Paying points to get a lower rate on a mortgage is almost always a losing proposition.
That’s because most homeowners don’t keep their mortgages long enough to do more than recoup the up-front cost of paying points.
A point is 1% of your loan amount. If you take out a $250,000 mortgage, 1 point equals $2,500.
In the mortgage world, there are two types of mortgage points:
- Origination points are a fee you must pay a bank or mortgage company to give you a loan.
- Discount points (the focus of this story) lower the interest rate on your loan and reduce your monthly payments.
Borrowers get a lower rate for paying discount points because they're prepaying a portion of the interest on their loan.
Indeed, discount points are tax-deductible, just like the interest you pay with each monthly mortgage payment. (According to the IRS, 2.7 million of the 45.5 million federal tax returns filed in 2012 took a deduction for discount points.)
How much can you lower your interest rate by paying points?
Anywhere from one-eighth to one-quarter of a percentage point per discount point.
A range like that makes it absolutely critical to compare offers that include points to those that don't and determine how much you're really saving by paying thousands of extra dollars up front.
Some banks and mortgage companies actually promote interest rates in their advertising that are only available by paying points. They hope you'll be so wowed by a rate that looks like it's lower than competitors are charging that you won't notice the additional up-front cost.
The key question you need to ask is: How long will it take me to recoup what I spend on points through lower monthly mortgage payments?
Considering two typical 30-year fixed-rate mortgages quickly shows how much paying a point will save (or cost) you on a typical $100,000 mortgage.
- Mortgage Option 1: 4% interest rate with no points
- Mortgage Option 2: 3.875% interest rate with 1 point
Paying Points: The Tale of Two Loans