Mortgage Discount Points: What You Need to Know

You can trust that we maintain strict editorial integrity in our writing and assessments; however, we receive compensation when you click on links to products from our partners and get approved. Here's how we make money.
discount points

When you take out a mortgage loan, you run into a lot of closing costs, and few are optional. Most lenders, however, will give you the option to buy mortgage discount points, which can lower your interest rate. You may also get the chance to receive a negative point credit, though this will raise your interest rate.

Here’s the lowdown on what mortgage points are, how they work and when you should and shouldn’t use them.

What are mortgage points?

A mortgage point can be either positive or negative, though positive points are much more common. Buying a positive, or discount, point or receiving a negative point changes your mortgage interest rate. Each kind of point costs 1% of your mortgage loan amount. For example, if you have a $100,000 mortgage, you’d pay $1,000 for one discount point.

How do discount points work?

A discount point is essentially prepaid interest: You pay an upfront fee to lower the interest rate on your mortgage. Because purchasing points lowers your interest rate, buying them is often known as “buying down the rate.”

Discount points may be tax-deductible if the purchase is for your primary residence. Before buying points, you should have your lender give you an estimate for both scenarios — your mortgage closing costs if you buy points and if you don’t — says Ann Thompson, a divisional sales executive at Bank of America. She recommends then taking these two estimates to your tax professional to learn if points are tax-deductible for you and how each option would affect your overall tax situation.

» MORE: Determine whether you should buy mortgage points with our calculator

How do negative points work?

Negative points, sometimes called rebate points, are different: The lender offers to give you a credit by paying some of your fees in exchange for a higher interest rate.

This is sometimes called a no-cost mortgage. Negative points can be paid either to a broker as part of his or her compensation or to the borrower to cover closing costs. When a lender offers you negative points, it is effectively saying it’ll cover some of your mortgage fees and charge you a higher interest rate in return.

The credit from negative points cannot exceed the mortgage closing costs, and these points can’t be used as part of a down payment. Thompson says points can be used to cover some nonrecurring closing costs, such as bank and title fees, but they can’t cover recurring fees like interest or property tax.

Why would you willingly take a higher interest rate? If you’re short on money needed for closing costs, “you may want to pay a little bit more in interest over the life of the loan to have some of that covered,” Thompson says. Another reason might be if you want to hang onto some cash for improvements before you move in and can afford a higher monthly payment.

How much is a point worth?

There’s no set amount for how much a point will lower or increase your rate, Thompson says. It varies by the type of loan, the lender and prevailing rates, since mortgage rates fluctuate daily.

On the day of the interview with Thompson, June 5, buying a point on a fixed-rate loan lowered the rate by a quarter of a percentage point. On an adjustable-rate mortgage, the rate would drop three-eighths of a percentage point.

At Guaranteed Rate, a national lender, the savings are similar: Buying one point will typically lower your rate a quarter, or perhaps three-eighths, of a percentage point, says Dan Gjeldum, senior vice president of mortgage lending.

When should you buy points?

Deciding whether to buy mortgage discount points is always a case-by-case decision, though it typically comes down to two factors: time and money. How long will you stay in the house, and how much can you afford to pay to close your mortgage?

The key factor is how long you think you’ll stay in the home. Then you can calculate at what point you’ll break even on the cost of the points (use our calculator here for a personalized recommendation on whether to buy points).

“I don’t personally ever encourage paying points simply because of the fact that it does take so long to make it up, especially for a first-time home buyer,” Gjeldum says. While it can make financial sense for some, first-time home buyers generally don’t hold the mortgage long enough to make up the upfront expense, he says.

That money may be better spent on improvements like paint, landscaping or new carpets, he adds.

It may make sense to buy points when you’re purchasing a long-term investment property or a home you plan to hold for many years, Thompson says, since you’ll reap savings after breaking even.

Here’s an example from Thompson to help demonstrate how long it can take to benefit from buying a point. Say you’re taking out a $400,000 loan. Since one point equals 1% of the loan, buying one discount point would cost you $4,000. So first, decide whether you can afford to pay that $4,000 on top of your existing closing costs.

Based on mortgage rates the day she was interviewed, Thompson said buying a point would save you roughly $57 a month on your mortgage bill. By dividing the cost of the point ($4,000) by the monthly cost ($57), you determine how many months it would take you to make up the cost of buying the point. In this example, it’s about 70 months, or almost six years.

That means if you planned to stay in the home for six years, you’d break even, and any longer than that, you’d save money. But if you moved out before then, you’d have lost money.

Gjeldum says buying points makes sense if the seller is willing to pay for it. Gjeldum and Thompson both say that if an employer is relocating you for work and offering to pay points to buy down your interest rate, it could also be worthwhile since you’re not the one shelling out money.

But don’t stress. We’ve broken down what you’ll have to pay — property taxes, mortgage insurance, title search fees and more. Closing costs will make more sense once you understand what they cover, and how they protect the biggest investment you’ll likely make in your lifetime.

The total you’ll pay can vary greatly according to your home’s purchase price. The average homebuyer will pay between about 2% and 5% of the loan amount in closing fees.

Your lender is required to outline your closing costs in the Loan Estimate and this Closing Disclosure you receive before the big settlement day. Take the time to review them closely and ask questions about things you don’t understand.

Here’s a closer look at the closing costs you’ll face.

» MORE: Calculate your expected closing costs

Property-related fees

Appraisal fee: It’s important to a lender to know if the property is worth as much as the amount being borrowed. This is for two reasons: The bank needs to verify that the amount you need for a loan is justified, and the bank also wants to make sure it can recoup the value of the home if you default on your loan. The average cost of a home appraisal by a certified professional appraiser ranges between $300 and $400.

Home inspection: Most lenders require a home inspection, especially if you’re getting a government-insured mortgage. Before lending you hundreds of thousands of dollars, a bank needs to make sure the home is structurally sound and in good enough shape to live in. If the inspection turns up troubling results, you may be able to negotiate a lower sale price. But depending on how severe the problems are, you have the option to back out of your contract if you and the seller can’t come to an agreement on how to fix the issues. Home inspection fees, on average, range from $300 to $500.

Loan-related fees

Application fee: This covers the cost of processing your request for a new loan and includes costs such as credit checks and administrative expenses. The application fee varies depending on the lender and the amount of work it takes to process your loan application.

Assumption fee: If you take over (“assume”) the remaining balance of the seller’s mortgage, you may be charged a variable fee based on the balance.

Attorney’s fees: A number of states require an attorney to be present at the closing of a real estate purchase. Depending on how many hours the attorney works your case, the fee can vary dramatically.

Prepaid interest: Most lenders require buyers to pay the interest that accrues on the mortgage between the date of settlement and the first monthly payment due date, so be prepared to pay that amount at closing; it will depend on your loan size.

Loan origination fee: This is a big one. It’s also known as an underwriting fee, administrative fee or processing fee. The loan origination fee is a charge by the lender for evaluating and preparing your mortgage loan. This can cover document preparation, notary fees and the lender’s attorney fees. Expect to pay about 1% of the amount you’re borrowing (a $300,000 loan, for example, would result in a loan origination fee of $3,000).

Points: By paying points, you reduce the interest rate you pay over the life of your loan, which results in more competitive mortgage rates. One point equals 1% of the loan amount. So if the loan were $500,000, a 1-point payment would be $5,000. Generally, paying points is worthwhile only if you plan to stay in the home for a long time. Otherwise, the upfront cost isn’t worth it.

Mortgage broker fee: If you work with a mortgage broker to find a loan, the broker will usually charge a commission as a percentage of the loan amount. The commission averages from 1% to 2% of the home’s purchase price.

Mortgage insurance fees

Mortgage insurance application fee: If you put less than 20% down, you may have to get private mortgage insurance. (PMI insures the lender in case you default; it doesn’t insure the home.) The application fee varies by lender.

Upfront mortgage insurance: Some lenders require borrowers to pay the first year’s mortgage insurance premium upfront, while others ask for a lump-sum payment that covers the life of the loan. Expect to pay from 0.55% to 2.25% of the purchase price for mortgage insurance, according to Genworth and the Urban Institute.

FHA, VA and USDA fees: If your loan is insured by the Federal Housing Administration, you’ll have to pay FHA mortgage insurance premiums; if it’s insured by the Department of Veterans Affairs or the U.S. Department of Agriculture, you’ll pay guarantee fees. FHA insurance premiums are about 1.75% of the loan amount, while USDA loan guarantee fees are 2%. VA loan guarantee fees range from 1.25% to 3.3% of the loan amount, depending on the size of your down payment.

Property taxes and insurance

Annual assessments: If your condo or homeowner’s association requires an annual fee, you might have to pay it upfront in one lump sum.

Homeowner’s insurance premium: Usually, your lender requires that you purchase homeowner’s insurance before settlement, which covers the property in case of vandalism, damage and so on. Some condo associations include insurance in the monthly condo fee. The amount varies depending on where you live, your home’s value, and whether it’s in a potential disaster area (such as a flood plain or earthquake zone).

Property taxes: Buyers typically pay two months’ worth of city and county property taxes at closing.

Title fees

Title search fee: A title search is conducted to ensure that the person selling the house actually owns it and that there are no outstanding claims or liens against the property. This can be fairly labor-intensive, especially if the real estate records aren’t computerized. Title search fees are about $200, but can vary among title companies by region.

Lender’s title insurance: Most lenders require what’s called a loan policy; it protects them in case there’s an error in the title search and someone makes a claim of ownership on the property after it’s sold.

Owner’s title insurance: You should also consider purchasing title insurance to protect yourself in case title problems or claims are made on your home after closing.

More from NerdWallet:
Get preapproved for your mortgage
Mortgage points calculator
Compare mortgage rates now

Emily Starbuck Crone is a staff writer at NerdWallet, a personal finance website. Email: emily.crone@nerdwallet.com.

Updated June 12, 2017