Mortgage discount points are portions of a borrower’s mortgage interest that they elect to pay up front. By paying points up front, borrowers are able to lower their interest rate for the term of their loan. If you plan to stay in your home for at least 10 to 15 years, then buying mortgage points may be worthwhile.
What Are Mortgage Points?
Mortgage points represent a percentage of an underlying loan amount (one point equals 1% of the loan amount). Mortgage points are an additional upfront cost when you close on your loan, but they’re also a way for borrowers to negotiate a lower interest rate on their mortgage. For example, by paying upfront 1% of the total interest to be charged over the life of a loan, borrowers can typically unlock mortgage rates that are about 0.25% lower.
It’s important to understand that points do not constitute a larger down payment. Instead, borrowers “buy” points from a lender for the right to a lower rate for the life of their loan. Buying points does not help you build equity in a property—you just save money on interest.
Discount Points Vs. Origination Points
There are two different types of mortgage points: origination points and discount points. Discount points represent prepaid interest that can be used to negotiate a lower interest rate for the term of a loan.
Origination points, on the other hand, are lender fees that are charged for closing on a loan. Origination points don’t save borrowers money on interest, although they can sometimes be rolled into the balance of a loan and paid off over time. Discount points, however, have to be paid up front.
How Discount Points Work
When you apply for a loan and get approved, your lender will give you a loan offer. In your offer, the lender will typically offer you multiple rates, including a base rate, as well as lower rates that you can get if you purchase discount points.
Those discount points represent interest that you’re repaying on your loan. If you decide to purchase points, you pay the lender a percentage of your loan amount at closing and, in exchange, you get a lower interest rate for the loan term. Typically, for every point you purchase, you get to lower your interest rate by 0.25%.
Like normal mortgage interest that you pay over the life of your loan, mortgage points are typically tax-deductible. However, points are usually only used for fixed-rate loans. They’re available for adjustable-rate mortgages (ARMs), but when you buy them, they only lower your rate for your intro period—several years or longer—until the rate adjusts.
When Paying Points Is Worth It
When you buy discount points, you decrease your monthly payment, but you increase the upfront cost of your loan. Due to the difference in monthly payments, it usually takes between five and 10 years to recoup the upfront cost of discount points.
Instead of buying points, many borrowers instead choose to make larger down payments (or make extra payments on their mortgages) in order to build equity in their homes quicker and pay off their mortgages early, another way to save money on interest payments.
Still, in some cases, buying points may be worthwhile, including when:
- You need to lower your monthly interest cost to make a mortgage more affordable
- Your credit score doesn’t qualify you for the lowest rates available
- You have extra money to put down and want the upfront tax deduction
- You plan to keep your home for a long time, so you may recoup the cost
Of course, this really only applies to discount points. Origination points, on the other hand, are closing costs paid to a lender in order to secure a loan. While these fees are sometimes negotiable, borrowers usually have no choice about whether to pay them in order to secure a loan.
Mortgage Points Example
Let’s say a prospective homeowner applies for a $400,000, 30-year mortgage so they can buy a $500,000 house. They have good credit and plenty of income, so they get approved. After underwriting, they get a loan offer from a lender that includes multiple rates—one with their rate if they purchase no points, plus alternative rates if they purchase one to four discount points.
Below are sample rates for this borrower, upfront costs to purchase those points and respective monthly payments for each rate:
In this case, each point would save the borrower about $60 per month. It would take a borrower 66 months (roughly 5.5 years) to recoup the cost of each discount point they purchase.
How to Negotiate Mortgage Points
When you apply for a loan, both discount points and origination points are theoretically negotiable. But, in practice, that’s not always the case. The only way to know for sure is to speak with your loan officer once you’ve been approved for a loan.
If you want to successfully negotiate either discount or origination points, one of the best things you can do is to apply for mortgages from multiple lenders. Then, when you get loan offers, you can let each lender work to earn your business by negotiating lower rates or closing costs.
You don’t need to worry about this hurting your credit score, as credit bureaus treat credit checks from multiple mortgage lenders within about a 30-day period as one credit check. They assume that you’re shopping around for the best rates, which you should do.
Deducting Mortgage Points on Your Income Taxes
When you purchase discount points (or “buy down your rate”) on a new mortgage, the cost of these points represent prepaid interest, so they can usually be deducted from your taxes just like normal mortgage interest.
However, you can usually only deduct points paid on the first $750,000 borrowed. In other words, if you take out a $1 million mortgage and buy one point for $100,000, you can only deduct $75,000 (1% times $750,000). The extra expense—paid on the last $250,000—is not tax-deductible.
According to the IRS, the expenses for mortgage points can be itemized on Schedule A of your Form 1040. The IRS says that “if you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage.”
How Mortgage Points Affect Closing Costs
Mortgage points—both discount points and origination points—increase a borrower’s upfront cost of getting a mortgage. However, neither of these costs increases your equity in the property you’re borrowing against.
In the case of discount points, these costs are also optional. If you plan to stay in your home for at least 10 to 15 years and want to reduce the monthly cost of your mortgage, they may be worthwhile, but they aren’t required.