Mortgage points, sometimes referred to just as points, are a way to purchase a lower interest rate from your mortgage lender. You can get a lower rate for the life of your loan by agreeing to pay this fee to the lender at the onset of your mortgage.
But is this actually a good idea? The short answer is that it depends on your personal situation.
Money expert Clark Howard says that most homebuyers should not opt for the upfront fee, because you may not stay in the home long enough to reap the benefits of your point purchase.
In this article, I’ll explore what mortgage points are, how they work and examine what makes a borrower a good candidate to purchase points.
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What Are Mortgage Points?
Mortgage points are a fee or interest pre-payment paid to your lender in exchange for a lower interest rate on your home loan. You pay these fees at the time of closing, and the money does not go toward the principal of your new mortgage. It goes straight to the lender as compensation for offering you the lower rate.
Buying points can help you lower the interest rate on your mortgage, but it could actually cost you money if you don’t stay in the home — with the same loan — for a long period of time.
Discount Points vs. Origination Points
In addition to the term “mortgage points,” you may see advertised interest rates requiring “discount points” or “origination points.”
While both discount and origination points are potential parts of your closing costs on a loan, they are not the same thing:
Discount Points: This is an interest pre-payment to your lender during the closing process in exchange for a discounted interest rate. These are most commonly synonymous with the term "mortgage points."
Origination Points: This is a transaction fee charged by some lenders for things like evaluation, processing and approval of the loan. Other lenders may instead market these costs associated with creating a loan as "origination fees." Either way, the "fee" or "points" are due at the closing of the loan. And they are not an interest pre-payment. Clark strongly recommends avoiding "junk fees" associated with loan origination, so be sure to study these points carefully if your loan offer has them.
For the purposes of this article, we’ll be focusing on discount points and whether or not you should pay them. When we reference mortgage points, we’re referring to discount points— not origination points.
How Do Mortgage Points Work?
When getting quotes for your mortgage, you may notice that you can be quoted rates with or without discount points.
Typically, one point will cost you 1% of your total mortgage amount. So if you borrow $300,000 for a home, you can expect your point to cost $3,000. If you agree to two points, you’ll owe $6,000 at closing.
In exchange for these points, you’re reducing your interest rate for the life of the loan.
There is no “set value” for how much of a rate reduction a point buys you. But you can expect that each point will net you a reduction in your interest rate of somewhere between .25% and .375%.
The value of the points is usually pre-determined by the lending model at each individual institution. But that doesn’t mean you can’t ask for a bump in value, nor does it preclude institutions from making non-advertised offers to compete for your business.
Continuing with our example, let’s say you were quoted 3.50% on that $300,000 loan. You’d likely be able to buy it down to 3.25% if you pay one point at closing or even 3.00% with two points.
From there, you’d have to evaluate how long it will take you to break even on your investment in the points through savings on interest owed for your loan.
Here’s a breakdown of how this example could work:
| Loan with No Points | Loan with One Point | Loan with Two Points | |
|---|---|---|---|
| Mortgage Interest Rate | 3.50% | 3.25% | 3.00% |
| Points Fee Due at Closing | $0 | $3,000 | $6,000 |
| Monthly Payment | $1,347.13 | $1,305.62 | $1,264.81 |
| Months Until Breakeven Through Interest Savings | N/A | 72 months | 73 months |
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These are just some examples of how points can work to reduce your mortgage interest rate.
Points are separate from the down payment that you need to provide at closing, and there are almost always other, administrative fees you’ll have to pay.
Should I Pay Points on My Mortgage?
The answer to this question likely lies in your long-term plans for the home.
You want to make sure that you break even on the points that you paid well in advance of when you plan to sell the home.
Clark Howard’s Philosophy
Money expert Clark Howard is not a fan of paying any unnecessary fees when taking out a mortgage on a home. That distaste for fees extends to buying down the rate on the loan with discount points.
"If someone says 'Oh, we're going to be here maybe 3 to 5 years' then you don't want to be paying any points," Clark says. "You need to be of a mode in your thought process that saying 'We're going to be here a long, long time' before you can even consider it."
Clark says it’s important to remember that even if you think you’ll be in a home for the long term, life events like a job relocation, family changes or health concerns can unexpectedly alter your plans.
"You can buy a place and think 'We're going to be here forever' but then who knows what happens," Clark says. "You can't insure against every possibility in life. But with anything having to do with a home, the longer you plan to stay the easier or more clear financial decisions like that become."
Mortgage Points Calculator
If you know that you’re going to keep the same mortgage for years to come, you may be a good candidate for paying points on your loan to reduce the interest rate.
In order to understand the dollars and cents behind this decision, Team Clark has developed an easy-to-use mortgage points calculator.
How This Mortgage Points Calculator Works
This calculator works by comparing two different financing options (points and interest rates) for loans with the same amount and length.
When comparing the loans, enter the loan with fewer or zero points first.
Your Results
The cost (in points) for loan 1 is {{ discountPoints1Amount }}. The cost (in points) for loan 2 is {{ discountPoints2Amount }}. This is a cost difference of {{ discountSpread }}.
The payment amount for loan 1 is {{ monthlyPayment1 }}. The payment amount for loan 2 is {{ monthlyPayment2 }}. This is a payment difference of {{ calc_monthlyPaymentDiff }}.
Based on the difference in your loan payment, it will take {{ breakeven }} months ({{ calc_breakevenYears }} years) to recover the cost of paying points.
In this scenario, it would only be worth paying points if you are sure you are going to be in your home for longer than {{ calc_breakevenYears }} years.
How Mortgage Points Impact Refinancing
Are you trying to decide if paying points is worth it on a refinanced mortgage? There are some additional factors you’ll need to consider.
Why Paying Now May Hurt You Later
Paying down points for a “great deal” on a low mortgage interest rate sounds like a good idea … right up until rates go down.
For example, the average 30-year mortgage interest rate in 2018 was 4.54% according to Value Penguin's data. By September 2020, the average mortgage interest rate had plummeted to 3.09% according to Nerd Wallet.
If you had bought a point in 2018 to lower your rate from 4.54% to 4.29%, you’d still be paying off the investment you made in that point while rates have dropped well below the rate you got for it.
You may still be able to refinance, but you will probably have to eat the cost of that point you bought.
Finding Your Breakeven Point on a Refinanced Loan
If you're trying to decide if you should pay points on a refinanced loan, Clark has both a special refinancing rule and a refinance calculator that can help.
Clark says that the money you save on mortgage interest (because of a lower rate) should recoup the closing costs for your refinance within the first 30 months of the new loan. If not, you’re at risk of losing money on the transaction if you have to sell your home in the short term— even if you’re making a lower monthly payment.
You can use his refinance calculator to determine if points owed on a refinance fit that parameter.
As you might expect, the lower you’re able to make your interest rate by paying points, the quicker you’re going to recoup your investment. So a point that is worth 0.375% off the loan is going to be more valuable than one that is only worth 0.25%.
Final Thought
If you are shopping for a new or refinanced mortgage, points are going to be something you’ll be forced to consider while getting quotes.
Clark says it’s best to avoid paying for discount points unless you’re absolutely sure that you’re going to be in the loan long enough to yield a positive return on your investment.
Team Clark's advice is to use our mortgage points calculator to get a better picture of your breakeven point on paying points for a lower rate. If you're able to see a clear path to that date and the financial upside of the reduced rate is clear, you can cautiously move forward with paying points.
However, you must also consider that it likely will hinder your ability to refinance into a better rate should you pay points and then watch the market for non-point rates drop below what you’re paying.
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