What a point is
A discount point is an upfront fee you pay the lender at closing in exchange for a lower interest rate. The Consumer Financial Protection Bureau (CFPB) defines the price: one point equals one percent of the loan amount, so a point on a $400,000 loan costs $4,000. Points can be fractional, 0.5 or 1.375 are common, and the fee is listed on page 2, section A of the Loan Estimate and the Closing Disclosure under origination charges. The CFPB's Loan Estimate explainer notes that if there is an amount on that line, you are paying points to the lender to reduce your interest rate, and that a similar loan may also be available without points.
Lender credits are the same deal in reverse: you accept a higher interest rate and the lender gives you money toward your closing costs, shown as a negative number in section J. One offer can be laid against the other on the same form.
What a point buys
There is no fixed exchange rate. The CFPB says how much a point lowers the rate depends on the lender, the type of loan and market conditions. Its own example: on a $180,000 loan, 0.375 points lower the rate from 5.00% to 4.875%, which costs $675 and saves about $13.70 a month. So the first thing to ask a lender is for two Loan Estimates for the same loan, one with points and one without; the difference between their rates is the only reliable figure.
The break-even
For the CFPB example: $675 ÷ $13.70 = about 50 months. Keep the loan longer than that and the points were worth buying; sell or refinance before it and they were not. The break-even calculator and the payback period calculator do the same division for any upfront cost and monthly saving, and the refinance calculator has a points field built in.
The table takes a $400,000 loan over 30 years at 6.5% with no points and assumes each half point lowers the rate by 0.125 percentage points, the ratio in the CFPB's example. Your lender's quote replaces that assumption. The last columns show the net result, savings minus the cost of the points, after 5, 7, 10 and 30 years.
| Points | Rate | Cost | Payment | Saving per month | Break-even | After 5 yrs | After 7 yrs | After 10 yrs | After 30 yrs |
|---|---|---|---|---|---|---|---|---|---|
| 0 | 6.500% | $0 | $2,528.27 | none | no points | $0 | $0 | $0 | $0 |
| 0.5 | 6.375% | $2,000 | $2,495.48 | $32.79 | 61 months (5.1 years) | −$32 | $755 | $1,935 | $9,805 |
| 1 | 6.250% | $4,000 | $2,462.87 | $65.40 | 62 months (5.1 years) | −$76 | $1,494 | $3,848 | $19,545 |
| 1.5 | 6.125% | $6,000 | $2,430.44 | $97.83 | 62 months (5.1 years) | −$130 | $2,218 | $5,740 | $29,219 |
| 2 | 6.000% | $8,000 | $2,398.20 | $130.07 | 62 months (5.1 years) | −$196 | $2,926 | $7,608 | $38,825 |
With these inputs one point costs $4,000, saves $65.40 a month and breaks even after 62 months (5.1 years). After 5 years the buyer is still $76 behind; after 10 years $3,848 ahead; over the full term $19,545 ahead, before counting what the $4,000 could have earned elsewhere. The break-even hardly moves between half a point and two points, because cost and saving scale together; what changes is the size of the bet.
The horizon decides
The CFPB's guidance is to decide on time, not on rate: points can make sense if you plan to keep the loan for a long time, and if you are not sure how long you will stay or when you might refinance, ask the loan officer for offers with and without points or credits and compare the total costs over the shortest, longest and most likely timeframes you might keep the loan. Three things shorten the horizon in practice:
- Moving. A sale pays the loan off, and any unreached break-even is a loss.
- Refinancing. If rates fall and you refinance, the lower rate you bought is gone with the old loan. Points on a loan you expect to refinance are the most expensive kind.
- Extra payments. Paying the loan down early shrinks the balance the lower rate works on, so the monthly saving falls over time. The table assumes the scheduled payment only.
The mortgage calculator shows the full payment for each rate, with taxes, insurance and PMI, so the comparison is between complete monthly figures and not just principal and interest.
Lender credits: the same choice backwards
A lender credit raises the rate in exchange for cash toward closing costs. The break-even runs the other way: the credit is money in your pocket now, and the higher payment is what you pay for it each month. If you expect to keep the loan for less time than the credit divided by the extra monthly payment, the credit wins. For someone short of cash at closing, or planning to move within a few years, credits are often the better side of the trade; for someone staying put, points are. The same two Loan Estimates answer both questions.
Points and taxes
The IRS treats points as a form of prepaid interest, so points that meet its criteria may be deductible as home mortgage interest, which means only if you itemize. For a mortgage to buy, build or improve your principal residence, the points can be deducted in the year you pay them when the IRS's conditions in Topic 504 are met. Points on a refinance, a second home or other loans are deducted ratably over the term of the loan, a thirtieth a year on a 30-year loan. A deduction lowers the real cost of the points and so shortens the break-even a little, but it does not change the logic.
Checklist
- Get two Loan Estimates for the same loan, with and without points, and read the rate and section A of each.
- Divide cost by monthly saving. That is the break-even in months.
- Compare it with how long you will keep the loan, on the shortest, longest and most likely estimate, as the CFPB suggests.
- Count the alternatives for the same cash: a larger down payment, paying off other debt, or keeping it as a reserve.
- Ask about the tax treatment if you itemize, and keep the Closing Disclosure.
Frequently asked questions
What is a mortgage point?
A discount point is an upfront fee you pay the lender at closing in exchange for a lower interest rate. The CFPB states that one point equals one percent of the loan amount: $4,000 on a $400,000 loan. Points can be fractional, such as 0.5 or 1.375. Lender credits are the opposite: a higher rate in exchange for money toward closing costs.
How much does one point lower the rate?
There is no fixed amount. The CFPB says the reduction depends on the lender, the type of loan and the market. In its example, 0.375 points lower a 5.00 percent rate to 4.875 percent, so a full point would be worth about a third of a percentage point at that lender on that day. The only number that matters is the one on your own two Loan Estimates, with and without points.
How do I calculate the break-even on points?
Divide the cost of the points by the monthly saving they produce. In the CFPB example the points cost $675 and save about $14 a month, which is a break-even of about 49 months. If you expect to keep the loan longer than that, the points pay off; if you sell or refinance sooner, they do not.
Are mortgage points tax deductible?
The IRS treats points as a form of prepaid interest, and points that meet certain criteria may be deductible as home mortgage interest if you itemize. Points paid to obtain a mortgage on your principal residence can be deducted in the year you pay them when the IRS's conditions are met; points on a refinance or a second home are deducted ratably over the term of the loan.
Should I buy points or make a bigger down payment?
Both use the same cash at closing, so compare what each buys. Points lower the rate on the whole loan; a bigger down payment lowers the balance, and below 80 percent loan-to-value it also removes private mortgage insurance. Run the mortgage calculator twice with the same cash and compare the payments and the break-even. The CFPB's advice on points is to compare total costs over the shortest, longest and most likely times you might keep the loan.
Sources
- CFPB: What are discount points and lender credits and how do they work? (one point equals one percent of the loan amount, the reduction depends on the lender, the 0.375-point example, lender credits, page 2 section A of the Loan Estimate, compare the shortest, longest and most likely timeframes)
- CFPB: Loan Estimate explainer (points are an upfront fee paid to the lender for a lower rate; a similar loan may be available without points)
- IRS Topic no. 504: Home mortgage points (prepaid interest, deductible as home mortgage interest if the criteria are met, in the year paid for a principal residence, ratably over the term otherwise)