What are Mortgage Points?

Mortgage points (also known as discount points) are fees paid directly to the lender at closing in exchange for a reduced interest rate. This is also called “buying down the rate,” which can lower your monthly mortgage payments.

One point costs 1 percent of your mortgage amount (or $1,000 for every $100,000). Essentially, you pay some interest up front in exchange for a lower interest rate over the life of your loan.

Let’s say you took out a mortgage for $200,000 and purchasing one point at $2,000 saves you 0.25 percent in interest, reducing your mortgage rate to 4 percent from 4.25 percent. Instead of paying $983 a month, you’re now paying $954, saving you $29 a month.  Over the life of the 30-year loan, you would save $10,502 in interest.

Calculations based on a 30-year, $200,000 loan

Break Even Analysis

It is important to consider how long it takes to recoup the cost of buying points. This is called the break-even period. To figure it out, divide the cost of the points by how much you save on your monthly payment. The resulting number is how long it takes for the monthly payment savings to equal the cost of the points.

For example, if you buy a house and your mortgage is $200,000, one point would cost you $2,000. That would lower your mortgage rate by .25 percentage points, so a 4 percent mortgage would become a 3.75 percent one.

This would reduce your monthly mortgage payment from $954.83 down to $926.23 which is a savings of $28.60 per month or $343.20 per year.

The Break Even Period for purchasing the Mortgage Point is 5.83 years.

Keep in mind that the $2,000 spent on the point could have been earning a return for you. At just 2 percent interest, that equals $40 a year, stretching your break-even longer.

Buying down your interest rate using Mortgage Points is better the longer you own the home. The longer you benefit from those lower payments, the better the return on investment you get from paying points.

If you do not expect to own the home for longer than the Break Even Period you should probably not purchase Mortgage Points.

What are Discount Points?

As stated earlier, Discount points are just another term for Mortgage Points. Discount Points are simply prepaid interest on the mortgage loan.

Are Mortgage Points Tax-Deductible?

Discount points can be deductible as mortgage interest on a primary residence or on a second home, even if it’s being rented out. However, there are some caveats.

These include:

• The loan must be secured against your home, whether it’s for a purchase or to build and improve the home.
• The money to buy the points must be paid directly to the lender.
• If you pay points to refinance a mortgage, you may have to spread out the deduction over the entire loan term.

Consult a tax professional if you have questions about the deductibility of mortgage points and interest.