Mortgage points explained: when buying down the rate pays off

Mortgage discount points are interest you prepay at closing in exchange for a lower rate. One point costs 1% of the loan amount, and each typically lowers the rate by around a quarter of a percentage point, though lenders vary. Points pay off only if you keep the loan long enough for the monthly savings to exceed the upfront cost. The mortgage points calculator finds that break-even month and the net result over the time you expect to keep the loan.

What a point is

Points are mostly a US feature. A discount point buys a lower rate; an origination point, if a lender charges one, is simply a fee for arranging the loan and buys nothing, so check which kind a quote contains. Some lenders also offer the reverse, sometimes called negative points or lender credits: a higher rate in exchange for money towards closing costs. The rate cut per point is not standard. Ask each lender for quotes at zero, one and two points so you can see their actual pricing.

The break-even calculation

The basic test is simple: divide the cost of the points by the monthly payment saving. The result is the number of months before the points have paid for themselves.

• Break-even months = cost of points ÷ monthly saving

Keep the loan longer than that and the points save money; sell or refinance sooner and they lose money. The calculator adds one refinement. Because a lower rate means more of each payment goes to principal, you also owe slightly less at any given point, and it counts that difference in the net result.

A worked example

Take a 320,000, 30-year loan at 6.75%. The monthly payment of principal and interest is about 2,075.51. Buying 2 points costs 6,400 and, at 0.25 per point, takes the rate to 6.25%, where the payment is about 1,970.30. The monthly saving is about 105.22, so the break-even is 6,400 ÷ 105.22, about 61 months, or just over five years. Counting both the payment savings and the lower balance, the net result is roughly:

• after 3 years: about −1,584 (the points have cost you money);
• after 5 years: about +1,636;
• after 7 years: about +4,851;
• after 10 years: about +9,629.

At five years the payment savings alone have not yet covered the cost, but the lower balance, about 1,723 less owed, tips the result positive. How mortgage amortization works, and why overpaying early matters explains why the principal share of each payment changes over time.

How long you will keep the loan

This is the question that decides it, and it is harder to answer than it looks. Many people move, or refinance when rates fall, well before 30 years, and either one ends the benefit of points. If rates are high when you buy and you might refinance in a few years if they drop, points are a weaker bet. If you expect to stay for a decade and rates are unlikely to fall far, they look better. Run the calculator with a pessimistic holding period as well as your expected one; the refinance calculator shows the other side of that decision.

Other uses for the cash

The money spent on points could go elsewhere, and the calculator does not count what it might earn. A bigger down payment can lower your loan-to-value into a cheaper band or help avoid mortgage insurance, which Loan-to-value explained: how your deposit shapes your mortgage covers and the loan-to-value calculator works out. Keeping the cash as an emergency fund protects you in the expensive first years of owning a home. And if two lenders quote different combinations of rate and points, the loan comparison calculator compares their total costs. Points make most sense when you have cash left after the deposit, closing costs and a solid emergency fund.

Tax and where points apply

In the US, points paid on a loan to buy your main home may be deductible, in some cases in the year you pay them, while points on a refinance are generally deducted over the life of the loan; IRS Topic 504 sets out the conditions, and a tax professional can confirm how they apply to you. The calculator leaves tax out. Outside the US, mortgages rarely use points, though some lenders offer a similar trade-off between a higher arrangement fee and a lower rate; the same break-even logic applies. Nothing you enter is stored, and the results are arithmetic, not advice.