Should you pay points on a mortgage?
What a point is
A point is an upfront fee you pay at closing in exchange for a lower interest rate. One point equals 1% of the loan amount. On a $400,000 loan, one point costs $4,000. Half a point costs $2,000.
How much a point lowers your rate is not fixed. It depends on the lender, the loan type and the market that day. Any rule of thumb you hear, such as "each point cuts the rate by a quarter percent," is only a rough guide. Ask each lender for its actual numbers.
Watch the wording. The Consumer Financial Protection Bureau (CFPB) notes that some lenders use the word "points" for any fee that is a percentage of the loan, even when it does not lower your rate. Points that appear on a Loan Estimate or Closing Disclosure should be tied to a lower rate. If a percentage fee shows up, ask the lender exactly what rate it buys.
The break-even math
The test is simple:
Here is an example. These rates are made up to show the arithmetic. They are not current offers.
| Option A: no points | Option B: 1 point | |
|---|---|---|
| Loan amount | $400,000 | $400,000 |
| Loan type | 30-year fixed | 30-year fixed |
| Rate | 6.50% | 6.25% |
| Paid at closing for points | $0 | $4,000 |
| Principal and interest | $2,528 / month | $2,463 / month |
Option B saves about $65 a month. Divide the $4,000 cost by $65 and you get about 61 months, a little over five years. Principal and interest are the only parts of the payment that change here. Taxes and insurance stay the same.
Here is what that looks like over different holding periods:
| If you keep the loan for | Payments saved | Cost of the point | Net result |
|---|---|---|---|
| 3 years | $2,355 | $4,000 | −$1,645 |
| 5 years | $3,924 | $4,000 | −$76 |
| 7 years | $5,494 | $4,000 | +$1,494 |
| 10 years | $7,848 | $4,000 | +$3,848 |
This is a first-pass test. It ignores what the $4,000 could earn elsewhere and the small difference in how fast each loan pays down principal. It is meant to show you the shape of the decision, not to replace a lender's side-by-side comparison.
Questions that matter more than the math
How long will you really keep this loan?
Many buyers sell or refinance well before the loan ends. The CFPB suggests asking a loan officer to compare your options with and without points over a short time, a long time and the time you think is most likely. If there is a real chance you will move or refinance within five years, a point in the example above would not have paid for itself.
Do you need the cash somewhere else?
Cash you pay for points is gone when you sell or refinance. It cannot go toward your down payment, repairs, moving costs or the savings you want to keep after closing. A larger cushion is often worth more than a small payment cut.
Might you refinance if rates fall?
If you refinance, you start over with new costs and the points you paid on the old loan stop working for you.
What about taxes?
How points are treated at tax time depends on your situation. This guide does not cover it. Ask a tax professional.
Lender credits: the opposite trade
A lender credit works the other way. You accept a higher interest rate, and the lender gives you money that offsets your closing costs. It can help when cash at closing is tight or when you expect to sell or refinance soon. The cost is a higher payment every month for as long as you keep the loan.
How to compare offers fairly
- Get Loan Estimates from at least three lenders. The CFPB recommends comparing more than one. Request them on the same day, because rates move.
- Ask each lender for the same terms: the same loan amount, loan type, loan term and rate lock period.
- Ask for two versions from each lender: one with no points and one with points. Better still, add a version with a lender credit.
- Compare the same lines. Page 1 shows the rate, monthly payment and cash needed at closing. Page 2 shows origination charges, points, lender credits and the services you can shop for. Page 3 shows the APR, which helps you compare total cost across offers.
- Do the break-even for each option with the formula above.
Five questions to ask each lender
- What is the rate and the cost at zero points, half a point and one point?
- Is any percentage fee on the estimate not tied to the rate?
- How long is the rate lock, and what does it cost to extend it?
- How many months to break even on each option?
- If I take a lender credit instead, what does my rate and monthly payment become?
This guide is for education only. It is not advice about your loan and is not an offer or quote. HomeBuyerLoanGuide does not make loans or refer you to lenders. Figures are examples. See our full disclaimer.
Sources
- How should I use lender credits and points (also called discount points)? Consumer Financial Protection Bureau.
- Loan Estimate explainer. Consumer Financial Protection Bureau.