What is Mortgage Points?

Detailed definition

Mortgage points are a way to trade upfront cash for a lower interest rate over the life of the loan. The lender accepts a chunk of prepaid interest at closing in exchange for charging you a lower coupon rate. On a $400,000 mortgage, one point costs $4,000 upfront and typically drops the rate from, say, 6.50% to 6.25%.

There are two types of points. Discount points reduce the rate and are the type most people mean. Origination points are pure compensation for the lender and do not lower the rate. The Loan Estimate (LE) and Closing Disclosure (CD) separate them. Discount points are deductible as mortgage interest (subject to itemizing), origination points are not.

The math hinges on break-even time. Calculate the monthly payment savings from buying the points, then divide the upfront cost by that monthly saving. The result is the number of months you must keep the loan for the points to pay off. If you sell, refinance, or pay off the mortgage before that date, you lost money buying points.

Lenders also sell negative points, sometimes called lender credits or rebate pricing. With negative points you accept a slightly higher interest rate, and the lender pays you a credit at closing toward closing costs. This is the mirror image of buying points: it makes sense when you need cash today (or expect to refinance or sell quickly) and are willing to pay more interest over a short holding period. Borrowers who are stretching to cover a down payment plus closing costs often use lender credits to make the deal close, even if the lifetime interest cost is higher.

The points-to-rate ratio is a key shopping metric. A lender offering "0.50 percentage points off for 1 point" is far more generous than one offering "0.20 off for 1 point" - yet both are common, and the difference can amount to tens of thousands of dollars over the life of a loan. Always compare ratios on Loan Estimates issued the same day, because rate sheets reprice daily. The ratio is also a clue to lender margins: aggressive points pricing often signals competitive correspondent or wholesale channels.

Formula

Break-Even (months) = (Points Cost) / (Monthly Payment Saving)

• Points Cost = Points x 1% x Loan Amount
• Monthly Payment Saving = Monthly payment without points minus monthly payment with points

Worked example

Suppose you take a $400,000 30-year fixed mortgage at 6.50% with no points. Buying 2 points costs $8,000 and drops the rate to 6.00%.

1. Loan amount: $400,000
2. Monthly payment at 6.50% (no points): $2,528
3. Monthly payment at 6.00% (2 points): $2,398
4. Monthly saving: $2,528 - $2,398 = $130
5. Break-even period: $8,000 / $130 = 61.5 months (5.1 years)

Extension - opportunity cost adjustment: the raw break-even of 5.1 years assumes the $8,000 sits as cash with no alternative use. If you would have invested that $8,000 in a brokerage account earning a real after-tax return of 5%, the true break-even stretches. Over 5 years, $8,000 compounds to roughly $10,210; the points need to save you the original $8,000 plus the forgone $2,210 of growth. That pushes the true break-even closer to 79 months (about 6.6 years). Conversely, if the alternative use was paying down high-rate credit card debt at 18%, buying points becomes worse - just retire the card first. The break-even formula on its own ignores this opportunity cost, so always sanity-check against where the cash would otherwise go.

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