How Mortgage Points Can Lower Your Interest Rate, Explained

Mortgage rates are at their highest level in years. On Sept. 8, the average rate for a 30-year fixed loan was over 6 percent. Now that mortgage interest rates are going up, you may want to consider buying mortgage points to help lower your monthly costs. Here are mortgage points explained in a little more detail.

When you buy a home, your lender will ask if you want to buy mortgage points. There are two types of mortgage points available — origination points and discount points. Both points usually cost 1 percent of your mortgage amount. So, for a $400,000 mortgage, one point would cost $4,000. You pay for the points at closing.

Mortgage origination points won’t help reduce the interest rate on your home loan. Origination points are more like fees that a lender charges to originate, review, and process your loan and pay for things like notary and inspection fees.

Discount points are what you can use to reduce the interest rate on your home loan. They act as a sort of prepaid interest. Each discount point costs 1 percent of your loan and is usually worth 0.25 percent. You can buy fractions of a point or up to three points.

For example, if you had a $400,000, 30-year fixed-rate mortgage at 6 percent, you could lower that interest rate to 5.5 percent by buying two mortgage discount points. The cost for those two points would be $8,000.

At 6 percent, your monthly mortgage payments would be about $2,398. By reducing the interest rate to 5.5 percent, your monthly cost would be $2,271. That saves you about $127 off your monthly mortgage payment. However, over the life of the 30-year loan, you would save about $45,736 in interest.

If interest rates are low, like they have been for many years, buying mortgage discount points might not provide enough savings to make it worth the investment. But now that interest rates are climbing while home prices remain high, it could be something to consider.

Before buying mortgage discount points, you should also consider how long you plan to live in the house you’re buying. If you’re paying $8,000 for points, you want to make sure you recoup that investment and then some.

The best return on your investment in points is if you plan to stay in the home for the entire term of the loan. If you only plan on staying in the house for about five years, you won’t save enough interest to make it worthwhile to purchase points. You also probably don’t want to buy mortgage points if you plan on refinancing your mortgage.

There are tax benefits to buying mortgage points. Since points are considered prepaid interest, you may be able to deduct the cost from your taxes. Your accountant can help figure out what deductions qualify.