When you look at mortgage quotes, you will often see options for "paying points." Mortgage points, also known as discount points, are a way to buy down your interest rate. In contrast, a "no-points" mortgage has no upfront cost but carries a slightly higher interest rate. Deciding which option is best depends on how long you plan to keep the loan.
What Are Mortgage Points?
One mortgage point costs 1% of your total loan amount. For example, on a $300,000 mortgage, one point costs $3,000. In exchange, lenders typically lower your interest rate by 0.25% (e.g., from 6.5% to 6.25%).
You can buy fractional points (like 0.5 points) or multiple points, depending on the lender's guidelines and your budget. Buying points is essentially prepaying interest at closing to secure a lower monthly payment for the life of your loan.
"The critical decision factor is your break-even point: divide the upfront cost of the points by your monthly payment savings."
Calculating the Break-Even Point
Let us look at a practical calculation to compare a points vs. no-points mortgage on a $300,000 loan:
- No-Points Mortgage: Interest rate of 6.5%. Monthly payment (Principal & Interest) = $1,896.
- 1-Point Mortgage: Upfront cost = $3,000. Interest rate reduced to 6.25%. Monthly payment = $1,847.
By paying $3,000 upfront, you save $49 per month ($1,896 - $1,847). To find your break-even point:
$3,000 / $49 = 61.2 months (approximately 5 years)
If you stay in the home and keep this mortgage for more than 5 years, paying the point will save you money. If you plan to sell or refinance in 3 or 4 years, you should choose the no-points loan.
Zero-Cost or Negative-Points Loans
Some lenders offer "lender credits" (sometimes called negative points). In this case, the lender gives you cash at closing to cover your closing costs in exchange for raising your interest rate. This is a good option if you are extremely short on cash at closing, but it will result in higher monthly payments and a higher total cost over the life of the loan.