Mortgage Points: What You Need to Know

When you’re in the market for a mortgage loan, you can get a lower interest rate by paying mortgage points. But what even are mortgage points and are these fees worth it? The answer to the latter question is complicated and depends on your financial situation.   

So, we will first start with the basics. The simplest answer is that mortgage points are a fee you can pay at closing in order to lower your interest rate. One point equals one percent of your loan amount. And if you’re taking out a $200,000 mortgage, buying one mortgage point would cost you $2,000.  

In this blog post, we’ll further explore the realities behind mortgage points and help you decide if they’re a good investment for you or not. We’ll look at how they impact your overall costs when buying a home so by the end of this post, you’ll have all the information you need to make an informed decision about whether paying extra for points is a good idea.  

What Exactly Are Mortgage Points?

To further explain, these mortgage points are a type of fee that you can pay in order to reduce the interest rate on your home loan. One point is equal to 1% of the loan amount.   

Many people who are actually sure they are buying their forever home, decide to get points on a mortgage because the interest savings can add up over the life of the loan. However, if you think you may sell your home or refinance your mortgage within a few years, paying points upfront may not be worth it since you won’t get to enjoy the full interest savings.  

You should also consider whether you have the cash on hand to pay for points. Paying for them with cash is always better than financing them into your mortgage because you will be effectively paying interest on top of interest. But if paying for points with cash would put a strain on your finances, it may not be worth it.  

We strongly advise you to talk to your lender about whether paying for mortgage points makes sense for your situation and compare offers from multiple lenders to see who is offering the best deal.  

Discount Points

Mortgage discount points are a type of prepaid interest that allows you to buy down your mortgage rate. They are the type we already discussed.  

And as we said the longer you stay in your home, the more savings you’ll realize from the lower interest rate. If you plan on selling your home within a few years, however, paying discount points may just end up being a more costly way since you won’t have time to recoup the upfront costs.  

And if you are unsure how long you are going to be in the house you are trying to buy, we suggest you consult with a financial advisor.  

Payment of mortgage points is optional. Some borrowers opt to pay them upfront in order to secure a lower interest rate on their loans, while others choose not to pay them in order to keep their upfront costs low. There’s no right or wrong answer when it comes to whether or not you should pay mortgage points and it ultimately depends on your financial situation and goals.  

Origination Points

When it comes to mortgages, there are a lot of things that go into the final cost of your loan. We already talked about discount mortgage points but there are also origination points.  

Origination points don’t affect the interest rate on your loan, and they are not discretionary, but mandatory. They are fees charged by a lender to originate, review and process your loan. Like the discount points, origination ones also typically equal 1 percent of the total mortgage.   

You pay your origination points as part of your closing costs when you finalize your home purchase.  

How Do Mortgage Points Work?

Points on a mortgage are fees a homebuyer can pay upfront in exchange for a slightly lower interest rate. Paying upfront essentially means that you will need to pay for as many points as you would like to purchase when you make a loan agreement.  

This is also referred to as “buying down the rate,” and is something that could potentially save you a lot of money in the long run.  

As with any other form of debt, interest charges can really eat into your budget and make it more costly to borrow money. This is especially when you need to take on such a large loan to pay for your house.  

Typically, you would buy points to lower your interest rate on a fixed-rate mortgage. Buying points for adjustable-rate mortgages only provides a discount on the initial fixed period of the loan and isn’t generally done.

When are Mortgage Points Worth Buying?

Points paid on a mortgage are worth buying in various cases:  

• You plan on staying in your home for a long time. The longer you stay in your home, the more you’ll save with a lower interest rate.  

• You have the cash to pay for them. Paying for points upfront will lower your monthly payments, but you’ll need to have the cash on hand to do it.  

• You’re getting a good deal. Make sure you compare mortgage rates with and without points before deciding whether or not to pay for them. It’s only worth paying for points if you’re getting a significantly lower interest rate. 

When are Mortgage Points Not Worth It?

Even though these points can be a great purchase, there are some cases when they are not worth it.   

First of all, if you think you may sell your home or refinance your mortgage within a few years, paying points upfront may not make sense because you won’t recoup the costs of the points.  

Additionally, while paying points may lower your monthly payment, it may also increase the size of your loan and the amount of interest if you can’t pay for them in full upfront. So, if you’re tight on budget and need every dollar to go towards your mortgage payment each month, paying points may not be the best option for you.   

Ultimately, whether or not paying mortgage points makes sense for you depends on your individual circumstances and financial goals. Be sure to speak with a lender or financial advisor to get personalized advice before making any decisions.  

Are Mortgage Points Tax Deductible?

Mortgage points are considered loan origination fees by the IRS and are therefore tax deductible. However, there are some limitations on how much you can deduct.   

You can deduct mortgage points in the year that you paid them. If you pay them over several years (through a refinance, for example), you can spread the deduction over the life of the loan.  

To deduct mortgage points, you must itemize your deductions on Schedule A of your Form 1040. This means that your total itemized deductions must exceed your standard deduction in order to benefit from it. For most people, this is only worth doing if they have significant other itemized deductions in addition to their mortgage points.  

Bottom Line

If you’re taking out a mortgage, you may be offered the option to pay for points. So, should you pay for them?   

That will greatly depend on your situation. If you are confident that the house you are buying will be your forever home, paying points upfront can save you money over the life of your loan. However, if you think there’s a chance you may sell your home before you’ve recouped the cost of the points, it may not be worth it.  

Talk to your lender about whether paying for points makes sense for you and compare offers from multiple lenders to see who’s offering the best deal.