Are Mortgage Points Worth Buying?

If you buy mortgage points, you can lower the interest you pay on your loan, whether you're buying a home or refinancing. But you'll only save money if you stay in the house long enough to make up for the upfront expense. Here's what you should know as you consider buying points on your mortgage.

[Read: Best Mortgage Lenders.]

What Are Mortgage Points?

Mortgage points, also known as discount points, are fees you pay your lender at closing for a reduced interest rate on your loan. The mortgage lender will receive cash up front in exchange for giving you a lower interest rate for the life of the loan.

Paying mortgage discount points is often called "buying down the rate" and could offer savings over the course of the loan, says Bryan Sherman, senior vice president and retail lending division executive at Bank of America.

Mortgage Discount Points vs. APR

If you purchase discount points, they might lower your interest rate, but they will still be part of the APR, or annual percentage rate, which is the true annual cost of the loan. The APR might also include broker fees, mortgage insurance premiums and fees for loan origination.

How Much Is a Mortgage Point?

One point costs 1% of your loan amount, or $1,000 for every $100,000. If your loan is $250,000, for instance, one point would cost $2,500.

Also, most lenders allow borrowers to buy fractional points: in the example above, $1,250 for half a point.

How Do Points Affect Your Mortgage Interest Rate?

Buying one point can reduce your interest rate by 0.25, but the exact discount can vary by lender. Lenders offer smaller interest rate discounts for fractional points: For instance, a half-point could buy you a 0.125 rate discount.

Consider this example of how 0.25% compounds over time. This chart shows how the monthly payment and the interest change at different rates on a $250,000, 30-year fixed-rate mortgage:

If you can lower your interest rate from 4.75% to 4.25% -- half a percentage point -- by paying for two points, you save nearly $22,000 over the life of the loan. That total savings factors in the $5,000 upfront cost.

Even a fraction of a percent really adds up. Anything you can do to chip away at your interest rate upfront can save significantly over time.

[Read: Best Mortgage Refinance Lenders.]

Is Buying Mortgage Points a Good Idea?

Buying points on a mortgage is a good idea only if you plan to make payments on your loan long enough to break even -- when what you paid for points equals your savings from a reduced interest rate.

A mortgage points calculator can help guide your decision.

"Consult a lending specialist to run the numbers to help determine how the points will affect your loan," Sherman says. "Under certain circumstances, buying mortgage points when you purchase a home can save you significant money over the course of your loan. But it's important to understand how they work and how long it takes for the additional upfront cost to be worthwhile. Additionally, you'll want to determine whether you have the cash available to buy points up front, in addition to your down payment, closing costs and reserves."

If you paid $5,000 to drop your rate from 4.75% to 4.25%, you would need to make regular monthly payments for at least 68 months to save more money than you spent on points. You will lose money if you purchase discount points and pay off your loan (by selling your home, refinancing or putting more toward the principal) before the break-even point.

The longer you have the loan, the more you will save using discount points. If you sell the home or pay off the loan in Month 68, your $5,000 investment will net you $50.36 in savings. But selling after 10 years will produce nearly $4,000 in savings, and that total grows to almost $13,000 after 20 years.

Paying Points vs. Making a Bigger Down Payment

"For many, paying for discount points on top of the other costs of buying a home is a financial stretch," says Joe Mileo, of marketplace development at mortgage lender Better.com.

Sometimes making a down payment big enough to avoid private mortgage insurance might be money better spent than coughing up cash for points. Lenders typically require PMI if the down payment is less than 20% of the purchase price.

Make sure you do the math before deciding what size down payment to make or buying points, Sherman says.

The average cost of PMI is about 1% of the total loan amount each year. You will have to pay PMI until you reach about 20% equity.

A larger down payment has another benefit. It helps you build equity faster in case you hope to borrow through a home equity loan or line of credit.

Should You Pay for Points on an Adjustable-Rate Mortgage?

Points on an adjustable-rate mortgage provide a discount only during the loan's initial fixed-rate period. The break-even point for 0.25 incremental rate discounts on these types of mortgages often falls between the four- and six-year marks. The initial fixed-rate period must be longer than the time to break even, or paying discount points won't be worth it.

Are Points Tax Deductible?

Yes, points for new and refinanced loans can be tax deductible if you follow the standards set by the IRS.

Here are some specifics:

-- You must itemize deductions on Schedule A.

-- If you can deduct all of your mortgage interest based on your filing status, you might be able to deduct all the points as well.

-- You can deduct points over the life of the loan or in full the year you pay them.

-- If you want to deduct in the year you pay, you must meet several requirements. One of these is that your primary residence, or the home you live in most of the time, must secure your loan.

-- You will need to deduct points paid for refinancing over the life of the loan unless you can show that you used some of the loan proceeds for home improvements. In that case, you can deduct points related to the improvements in the year you paid them and deduct the rest of the points over the life of the loan.

Is it Possible to Negotiate Points?

You can try to get the lowest interest rate possible by shopping around. Seek estimates from a few lenders to make sure you're getting the best deal. "Many lenders have some room to match competitors' rates in order to not lose your business," Mileo says.

Is it Possible to Add Mortgage Points After Closing?

You can't add points after the loan is closed, as the terms will be set, Mileo says. That's why it's important to weigh your options before you lock in your loan.

What Are Negative Discount Points?

Negative points are cash rebates from lenders that lower closing costs by raising interest rates.

The upside is that these lender credits reduce the amount of cash you need at closing, but the downside is that you will have to accept a higher interest rate over the life of your loan.

Some lenders advertise mortgages with little to no closing costs by offering negative discount points.

A mortgage with negative points makes the most sense if you want the lowest possible closing costs. You can reduce or avoid closing costs instead of rolling the costs into your mortgage and increasing the loan balance.

[Read: Best Adjustable-Rate Mortgage Lenders.]

Would Mortgage Points Work for You?

Whether to pay mortgage points depends on not only the break-even point, but also your plans for the home.

"In general, buying mortgage points is most beneficial when you both intend to stay in your home for a long period of time and can afford the upfront costs of mortgage points," Mileo says. "Sometimes that money is better spent on closing costs, but it all depends on your financial situation."

Most people stay in their homes for about eight years, according to a September 2020 report by ATTOM Data Solutions.

If you pay points when interest rates are low, you reduce the likelihood that you will need to refinance your loan later. As mortgage rates hover near historic lows, the fees for points may be lower than what you would have paid to refinance for your loan.

Getting the absolute lowest rate in a low-rate environment through paying points makes sense, Mileo says.

"You will likely never need to refinance and incur unnecessary closing costs again," he says.