Mortgage Points Explained

    Understanding discount points and when they make financial sense

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    What Are Mortgage Points?

    Mortgage points, also called discount points, are fees you pay to your lender at closing to reduce your interest rate. One point equals 1% of your loan amount and typically reduces your rate by about 0.25%, though this varies by lender and market conditions.

    Discount Points

    Points you pay to lower your interest rate permanently.

    Prepaid interest at closing

    Reduces your interest rate

    Tax deductible

    Lowers monthly payment

    Origination Points

    Fees paid to the lender for processing the loan.

    Lender compensation

    Does not reduce rate

    May be negotiable

    Sometimes called "points"

    Real-World Example

    Without Points

    • Loan Amount: $400,000
    • Interest Rate: 7.00%
    • Monthly Payment: $2,661
    • Total Interest (30 yrs): $558,191

    With 2 Points ($8,000)

    • Loan Amount: $400,000
    • Interest Rate: 6.50%
    • Monthly Payment: $2,528
    • Total Interest (30 yrs): $509,993

    Result:

    • • Monthly savings: $133
    • • Total interest saved: $48,198
    • • Break-even point: 60 months (5 years)
    • • Net benefit if held 30 years: $40,198

    When Buying Points Makes Sense

    • You plan to keep the loan long-term: The longer you hold the loan, the more you benefit from the reduced rate.
    • You have extra cash at closing: If your down payment is covered and you have funds available, points can be a smart investment.
    • Interest rates are high: In high-rate environments, the monthly savings from buying points is more significant.
    • You're in a high tax bracket: The tax deduction can enhance the benefit of points.
    • You won't have better investment returns: If your alternative investment can't beat the guaranteed "return" from points, buy them.

    When NOT to Buy Points

    • You plan to refinance soon: If rates are dropping or you expect to refinance within a few years, you won't recoup the cost.
    • You might sell before break-even: If you'll move before the break-even point (typically 3-7 years), skip the points.
    • Cash is tight: If paying points strains your emergency fund or prevents you from putting 20% down, prioritize those instead.
    • You have high-interest debt: Pay off credit cards or other high-rate debt first—they're costing you more.

    Key Calculation: Break-Even Point

    To calculate your break-even point, divide the cost of points by your monthly savings:

    Break-even = Cost of Points ÷ Monthly Savings

    Example: $8,000 ÷ $133 = 60 months (5 years)

    If you'll keep the loan longer than the break-even period, buying points is typically worthwhile. Always compare the guaranteed return from points against your other investment opportunities.

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