What Are Mortgage Points and How Do They Work?

Mortgage points are fees you pay to a lender to reduce the interest rate over the life of your loan. Essentially, by paying some interest upfront, you could save thousands of dollars on future interest payments. Since the national average for interest rates in November 2022 is sitting around 7%, buyers should understand that other options exist. On the flip side, buying mortgage points isn't the best solution for everyone, depending on factors like how long you plan to own the home, the total loan amount, and your down payment. Let's explore how much money you can save when buying mortgage points and whether doing so is the right option for you.

How Much Can You Save When Buying Mortgage Points?

With a fixed-rate mortgage and a plan to own your property for a while, buying mortgage points can save you a significant amount throughout your loan. Each mortgage point costs 1% of your total loan amount. Furthermore, each point you purchase reduces your interest rate by a set amount; one point is usually equal to a 0.25% interest rate reduction, but this varies by lender and program. 

Say you have a $200,000 30-year, fixed-rate mortgage at 7% interest. Over the 30-year lifetime of your loan, you would end up paying $279,160 in interest. Now, say you decide to purchase mortgage points to reduce your interest rate. One mortgage point on a $200,000 loan costs $2,000. If you buy two points for $4,000, you reduce your interest rate to 6.5%, which means you end up paying $255,040 in interest throughout the loan. In this scenario, $4,000 upfront would save you $24,120 in the long run.

Is Buying Mortgage Points Worth It?

If you have the cash available, and you want to determine whether buying mortgage points upfront is worth it, you need to calculate how many months it would take to reach your break-even point. In the example above, buying two mortgage points results in savings of $67 per month. That means it would take 60 months (5 years) to save the $4,000 you used to purchase the mortgage points. If this is your forever home, then buying the points makes sense, but if you are purchasing the home as a quick fix-and-flip, you'd be better off saving the $4,000 and paying a higher interest rate.

When Is Buying Mortgage Points a Bad Idea?

Mortgage points are part of a long-term strategy to reduce your overall interest payment. They are most beneficial when interest rates are high and climbing, you plan to stay in the house for a large portion of the loan period, and you have the money upfront. That said, you should avoid buying mortgage points if: 

1. Interest rates are down-trending and you plan to refinance. In this case, you'll secure a lower interest rate anyway and you don't have to pay for it. 

2. If you don't plan to stay in the home long enough to experience the long-term benefits. This is why you should calculate your break-even point. 

3. If you have to choose between mortgage points and your down payment. You should always prioritize your down payment over mortgage points because you can refinance down the line, but a low down payment could rope you into a PMI (private mortgage insurance) payment for the duration of your loan.

Is Now the Right Time to Buy?

If you're thinking about buying a home, don't let the current interest rates discourage you. Between buying mortgage points and refinancing, you have plenty of viable options to reduce your interest rate at the start or throughout your loan period. The best time to buy a home is when you're ready, and your real estate broker and lender can help you with the logistics.