Mortgage Points: Buying Down the Rate

Mortgage discount points are an upfront fee a borrower can pay at closing in exchange for a lower interest rate on the loan. The typical exchange rate is roughly one point, or one percent of the loan amount, paid upfront in exchange for a 0.25 percent reduction in the rate, though the actual ratio varies by lender and rate environment. The lower rate produces a smaller monthly payment, which over time can recoup the upfront cost. Whether buying points actually pays off depends on a small set of variables, mostly how long the borrower plans to hold the loan. The math is not complicated, but it is rarely run properly, which leads many borrowers to either overpay for unnecessary points or miss out on savings they would have benefited from.

How Points Are Priced and Quoted

When a borrower applies for a mortgage, the lender provides a rate sheet that shows several rate options. The lender's par rate is the rate available with zero points and zero lender credit. Above par, the borrower pays points to buy the rate down. Below par, the borrower receives a credit from the lender that can offset closing costs but comes with a higher rate. The exact tradeoffs change daily as the secondary mortgage market moves, and they can also vary across lenders quoting on the same day.

The standard quoting convention shows several rate-and-point combinations. For example, a lender might offer a 7.0 percent rate with zero points, a 6.75 percent rate with one point, and a 6.5 percent rate with two points. Some lenders break this down into fractional points like 0.5 or 0.75. The borrower picks the combination that fits their goals. A useful rule of thumb is that the further below par the borrower goes, the steeper the cost of each additional rate reduction becomes. The first quarter point of rate reduction is usually the cheapest, while later reductions get progressively more expensive per basis point.

The Break-Even Calculation in Plain Numbers

The break-even calculation is straightforward. Take the upfront cost of the points and divide by the monthly payment savings. The result is the number of months you have to keep the loan for the points to pay off. If you keep the loan longer than the break-even point, you come out ahead. If you sell, refinance, or pay off the loan sooner, you would have been better off skipping the points.

Here is a worked example. On a 300,000 dollar loan, one point costs 3,000 dollars upfront. If that point lowers the rate from 7.0 to 6.75 percent, the monthly principal and interest payment drops from about 1,996 dollars to about 1,946 dollars, a savings of 50 dollars per month. The break-even is 3,000 divided by 50, or 60 months. After five years, every additional month saves 50 dollars. If you keep the loan for ten years, you save 50 dollars per month for the five years past break-even, or roughly 3,000 dollars in net savings. If you refinance after three years, you paid 3,000 dollars upfront and only saved 1,800 dollars in monthly payments, so the points cost you 1,200 dollars net.

When Points Tend to Pay Off and When They Do Not

Points tend to pay off in situations where the borrower has a long expected holding period and is paying with funds that would not otherwise produce a strong return. A buyer purchasing a long-term family home with a steady income and no plans to move is a classic point-buying candidate, especially in a rate environment where future refinance opportunities seem limited. The 60-month break-even on the example above is well within their expected holding period, and the savings continue to compound year after year.

Points usually do not pay off in three common situations. The first is when the borrower expects to sell or refinance within a few years, putting the move before the break-even point. The second is when the buyer is stretching to qualify for the loan and the upfront cash would be better used as additional down payment or reserves. The third is in a rate environment where many borrowers expect to refinance within a year or two as rates fall. Paying for a rate buydown that gets refinanced away rarely makes sense. The mistake to avoid is treating point purchases as automatically smart because they sound like a deal. They are a financial transaction with a specific break-even, and the discipline of running the math protects against costly errors.

Lender Credits: Points in Reverse

Lender credits work like points in reverse. The borrower accepts a slightly higher rate in exchange for the lender covering some or all of the closing costs. This can be particularly useful for borrowers who want to minimize cash at closing, who are confident they will refinance or move within a few years, or who prefer to keep their reserves for other purposes. The break-even math runs the same way, just in reverse: the credit pays off your closing costs upfront, and the slightly higher payment costs you a known monthly amount.

A typical example might be that the borrower accepts a rate 0.25 percent higher than par in exchange for a lender credit of one percent of the loan amount toward closing costs. The break-even on a credit is often shorter than the break-even on points, simply because the upfront benefit is concrete cash today rather than a future stream of savings. Borrowers planning to hold the loan for the long term should think carefully before accepting credits that leave them paying a higher rate for decades. The right choice depends on the actual holding period, the cost of the alternatives, and the borrower's broader financial picture. Treat points and credits as two ends of the same dial rather than two separate products, and you will tend to make the right call.