Mortgage Points: A Guide to Buying Down Your Interest Rate

Paying mortgage points can lower your long-term interest costs, but the decision hinges on one key calculation: your breakeven point. If you plan to own the home longer than the time it takes for the monthly savings to equal the upfront cost, buying points is often financially advantageous. This guide explains how mortgage points work and how to determine if they are right for your loan.

What Are Mortgage Points?

Mortgage points, often called discount points, are an upfront fee paid to your lender at closing in exchange for a reduced interest rate on your home loan. This is also known as "buying down the rate." One point typically costs 1% of your total loan amount. For example, on a $400,000 mortgage, one point would cost $4,000. In return, your interest rate is generally reduced by 0.25%, though the exact reduction varies by lender and market conditions.

How Do You Calculate the Breakeven Point?

The most critical step in deciding on points is calculating your breakeven point—the number of months it takes for the cumulative monthly savings to equal the upfront cost of the points.

To calculate your breakeven point, use this formula: Cost of Points ÷ Monthly Savings = Breakeven Point (in months)

Consider this scenario based on recent average loan data:

• Loan Amount: $400,000
• Cost of One Point: $4,000 (1% of the loan)
• Rate Reduction: 0.25%
• Monthly Savings: Approximately $65

Breakeven Calculation: $4,000 / $65 ≈ 62 months

This means you would need to stay in the home and keep the mortgage for just over five years to recoup the initial investment. If you sell or refinance before this point, you likely will not recover the cost.

What Are the Disadvantages of Mortgage Points?

The primary drawback is the significant upfront cash requirement. This cost is separate from your down payment and closing costs, which can already be a financial strain. Based on our experience assessment, tying up thousands of dollars in points may not be feasible for every buyer.

There is also a clear risk if your plans change. If you sell the property or refinance the mortgage before reaching your breakeven point, the upfront cost is not recovered, resulting in a net loss. Furthermore, the funds used for points could potentially be directed toward other financial goals, such as investments or home improvements, which might offer a better return.

How Do Points Affect Your Down Payment and Closing?

It is crucial to understand that buying mortgage points does not affect your down payment. These are two separate transactions. Your down payment is a percentage of the home's purchase price that reduces your loan amount. Mortgage points are an additional, optional fee paid at closing to secure a lower interest rate.

When budgeting, you must account for both the down payment and the cost of any points you wish to purchase. Ensuring you have adequate funds for both without depleting your savings is essential for long-term financial stability.

Should You Buy Mortgage Points?

Your decision should be based on a careful assessment of your personal circumstances. Consider the following factors:

• Length of Homeownership: This is the most important factor. If you plan to live in the home significantly longer than your calculated breakeven point (e.g., 7-10 years versus a 5-year breakeven), buying points can lead to substantial long-term savings.
• Available Cash: You should only consider points if you have sufficient cash reserves after covering your down payment, closing costs, and maintaining an emergency fund.
• Current Interest Rate Environment: In a higher interest rate environment, the value of locking in a lower rate through points may be more pronounced.

Before committing, get a detailed Loan Estimate from your lender that clearly outlines the cost of points and the corresponding rate reduction. This allows you to perform an accurate breakeven analysis for your specific loan scenario.