Rate Direct

Mortgage points are a form of prepaid interest that allow you to lower your interest rate in exchange for an upfront fee. One discount point costs 1% of the loan amount and typically reduces your rate by approximately 0.25%. On a $400,000 loan, one point costs $4,000 and might lower your rate from 6.75% to 6.50%. Whether this trade-off is worth it depends on how long you keep the loan — and most borrowers get the analysis wrong.

How Discount Points Work

When you buy a point, you are prepaying interest to the lender at closing in exchange for a lower rate over the life of the loan. The amount of rate reduction per point varies by lender and market conditions but averages about 0.25% per point. You can buy fractional points (like 0.5 points for roughly 0.125% rate reduction) or multiple points. The rate reduction is not always linear — the first point usually buys the largest reduction, with diminishing returns for additional points. Some lenders offer their best pricing at a specific point level, so comparing total cost (rate plus points) is more meaningful than comparing rates alone.

Break-Even Analysis

The break-even point tells you how long it takes for the monthly savings to recoup the upfront cost of points. Divide the cost of the points by the monthly payment savings. For example: one point on a $400,000 loan costs $4,000 and saves $65/month. Break-even: $4,000 / $65 = 61.5 months (about 5 years). If you keep the loan longer than 5 years, the points save you money. If you sell or refinance sooner, you lose. The average homeowner keeps their mortgage for about 7 years, so in many cases points pay off — but not always. Factor in the opportunity cost: that $4,000 invested at 7% annual return would grow to about $5,600 in 5 years.

When Buying Points Makes Sense

Points make financial sense when you plan to stay in the home (and keep the mortgage) for longer than the break-even period, when you have excess cash beyond your down payment, closing costs, and emergency reserves, when the break-even period is relatively short (under 5 years), and when the alternative investment return on that cash would be lower than the effective return from the rate reduction. They are especially valuable for borrowers who plan to stay in their home for decades and want the lowest possible long-term cost. The effective return on buying points is often 6-10% annualized, which competes favorably with many investments.

When to Skip Points

Skip points when you might sell or refinance within 5 years, when you need to preserve cash for other priorities (emergency fund, home repairs, investments), when the break-even period is long (over 7 years), or when you can get a better risk-adjusted return investing the money elsewhere. First-time buyers in particular should be cautious about buying points — life circumstances change, and many first-time buyers move or refinance sooner than expected.

Negative Points: Lender Credits

The flip side of buying points is taking a higher rate in exchange for a lender credit toward closing costs. This is sometimes called negative points. For example, you might accept a rate of 7.00% instead of 6.75% and receive a $3,000 credit toward closing costs. This makes sense when you want to minimize cash out of pocket, you plan to refinance or sell within a few years, or you are comparing a no-closing-cost option. Rate Direct shows pricing across the point spectrum, including lender credit options, so you can see exactly what trade-offs are available for your scenario.

Points and Taxes

Mortgage discount points are generally tax-deductible. For a home purchase, points paid at closing can be fully deducted in the year they are paid. For a refinance, points must be amortized over the life of the loan (deducted proportionally each year). Consult a tax professional for your specific situation, but the deduction effectively reduces the net cost of buying points, which shortens the break-even period. On $4,000 in points, a borrower in the 24% federal tax bracket saves $960 in taxes, reducing the effective cost to $3,040 and the break-even to about 47 months.