5 Tips for Using Discount Points to Reduce Your Mortgage Rate

By Laura Adams, MBA

As mortgage rates move higher, you might be looking for ways to make a home purchase cost less. In addition to finding an affordable property, negotiating prices and shopping for the best mortgage rates, consider if buying discount points makes sense for you.

Discount points are an upfront fee you can pay for a reduced mortgage rate and lower monthly payments. If you have the loan long enough, your interest savings should exceed the upfront points cost. Here are five tips for using discount points wisely to save money on your next home loan.

1. Understand what discount points cost.

When you start mortgage shopping, you typically see rates with and without points.

One discount point costs 1% of your mortgage amount. For example, if you want a $300,000 mortgage, one point equals $3,000, 1.5 points are $4,500 and two points are $6,000.

While the per-point interest rate discount varies by lender, it's typically a 0.25% reduction. For instance, paying one point for a $300,000, 30-year, fixed-rate mortgage at 6.5% reduces it to 6.25%. 

In this example, your monthly payment would go from about $1,900 at the 6.5% rate to about $1,800 monthly at 6.25%. Your $100 monthly interest savings adds up to about $17,000 over the life of the loan. 

If you bought two points by paying $6,000 ($300,000 x 2%), your rate would come down to 6%, saving you nearly $35,000 in interest. Lenders typically cap the points you can buy, and most homebuyers who purchase them opt for between one and three.

2. Know your discount breakeven point.   

The breakeven on discount points occurs when your interest savings exceeds what you paid for them. In my previous example of buying one point on the $300,000 mortgage, you'd need to make payments for 30 months or three and a half years ($3,000 cost / $100 savings = 30 months) to recoup your $3,000 outlay. 

In other words, if you sold the property before owning it for 30 months, you'd lose money buying points. Knowing your breakeven point, or when you go from being in the red to saving money, is essential. Therefore, if you're unsure how long you'll stay in your home or plan to pay off your mortgage early, buying points likely won't help you.

3. Discount points may be tax deductible. 

In addition to paying less interest and lower monthly payments, points typically qualify as tax-deductible mortgage interest if you itemize deductions on your tax return. However, the IRS specifies that separate lender fees are not the same as mortgage interest.

So, buying points to reduce your lender's origination fee doesn't count as a tax-deductible expense. Learn more about discount points on the IRS website or consult a tax expert, mortgage lender or real estate professional for advice.

4. Consider the direction of rates before buying discount points. 

A potential downside of buying points is purchasing them before interest rates decline. That's because you could likely refinance your mortgage for a lower rate — if you have enough home equity — and skip paying for points.

However, refinancing a mortgage comes with costs, too. Depending on your mortgage type, income, credit and lender, they could range from 2% to 6% of your loan balance.

5. Negotiate with home sellers to pay points. 

A common challenge for homebuyers is being short on savings and unable to afford discount points. However, one way to buy them is by negotiating with a seller to pay them for you. For instance, you could make a purchase offer on a home, asking for a lump sum payment from the seller at closing to cover some or all of your points.

Sometimes, getting a seller to pay points could save more than offering a lower purchase price. But lenders may have rules about who can pay points and how much, so discuss it with them first. If a mortgage lender gives you the green light, let your real estate agent know how much you need a seller to chip in to make a deal work. 

Getting a mortgage is a big financial decision, so grab the opportunity to use points when it's wise for your situation. And remember that just about everything in real estate is negotiable, so be willing to make creative, win-win offers!

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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