What Are Mortgage Points and How Do They Work?
Somewhere in a loan estimate is a line offering to trade cash today for a lower rate over time. That’s what mortgage points do, and deciding whether the trade is worth it takes a little arithmetic.
The short answer
Mortgage points, also called discount points, are an upfront fee paid at closing in exchange for a lower interest rate on the loan. One point typically costs 1% of the loan amount and lowers the rate by a small, lender-set amount. Buying points only pays off if you keep the loan long enough for the monthly savings to exceed what you paid upfront.
How points work, step by step
- The lender sets a menu. At closing, or sometimes earlier during shopping, a lender offers a base rate and the option to “buy down” that rate by paying points, often in fractional increments.
- You pay the cost upfront. One point equals 1% of the loan amount, so on a sizable loan that can be a real amount of cash due at closing, on top of other closing costs.
- The rate, and the payment, drops. In exchange, the interest rate, and the APR, on the loan is reduced for the life of the loan, lowering the monthly principal-and-interest payment.
- The savings accrue slowly. Each month at the lower rate saves a small amount compared with the original rate; over enough months, those savings add up to more than the upfront cost.
Where points fit in the timeline
Points usually come up twice: once when shopping for a purchase loan, and again if refinancing. In a purchase, the decision to buy points competes with other uses of the same cash, such as a larger down payment, which can also affect PMI, or simply keeping more in reserve after the move. In a refinance, the same math applies, but it’s evaluated alongside the separate question of a refinance break-even calculation, since both involve comparing an upfront cost to a stream of future savings.
Finding the break-even point
The core question with points is simple to frame, if not always simple to answer: how many months of lower payments does it take to recover what you paid upfront? Divide the cost of the points by the monthly savings they produce, and the result is the break-even month. If the loan is paid off, refinanced, or the home sold before that month arrives, the points didn’t pay for themselves. If the loan is held well past that point, they did.
What to weigh
The math depends on assumptions that are genuinely uncertain at the time of the loan, chiefly, how long the loan will actually be held. A shorter expected time in the home or in the loan tends to favor skipping points and keeping the cash. A longer, more confident timeline shifts the math toward paying for a lower rate. There’s also an opportunity cost to consider: cash spent on points is cash that isn’t available for other goals, so the decision isn’t purely about the interest rate.
The bottom line
Mortgage points are a straightforward trade of cash now for a lower rate later, but straightforward doesn’t mean automatic. Running the specific break-even math against a realistic estimate of how long the loan will be held is what turns the point-buying decision from a guess into an informed choice.