Mortgage Points and Rate Buydowns: Are They Worth It?

Paying discount points is worth it only if you keep the loan longer than the break-even point: the upfront cost divided by the monthly savings. In our $500,000 example below, one point takes about five years to pay back, so if you are likely to sell or refinance sooner, you lose money.

A temporary 2-1 buydown is different: it lowers the payment for two years and then returns to the full rate. It is usually worth it only when someone else, typically the seller, pays for it.

What discount points are

The Consumer Financial Protection Bureau explains that points (also called discount points) lower your interest rate in exchange for paying more at closing. One point equals 1% of the loan amount, and lenders also quote fractions such as 0.5 or 0.125 points. The opposite is a lender credit: you accept a higher rate and the lender pays part of your closing costs. Credits appear as a negative number in Section J on page 2 of your Loan Estimate.

The CFPB’s example uses a $180,000 30-year fixed loan at 5.0% with zero points. Paying 0.375 points (about $675) gets 4.875% and saves about $14 a month. Taking 0.375 points as a credit gets about $675 toward closing costs at 5.125%, costing about $14 more a month.

How to calculate break-even

1. 1

   Get two quotes for the same loan

   One with no points and one with points. Same loan amount, term and lock period.
2. 2

   Find the cost

   Number of points × loan amount. 1 point on $500,000 = $5,000.
3. 3

   Find the monthly savings

   Subtract the lower principal-and-interest payment from the higher one.
4. 4

   Divide

   Cost ÷ monthly savings = months to break even.
5. 5

   Compare with your plans

   If you expect to sell or refinance before that month, skip the points.

Worked example

Here, both options take about five years to pay back. If you sell after three years with 1 point, you have saved about 36 × $83 = $2,975 in payments but paid $5,000, a loss of roughly $2,000. Keep the loan 10 years and you save about $9,900 in payments for the same $5,000.

When paying points loses money

• You are likely to move or sell before the break-even month.
• Rates may fall and you would refinance; the points you paid are gone when the old loan is paid off.
• The cash would leave you short on reserves, or below a co-op board’s post-closing liquidity requirement.
• The lender’s price per point is poor. Ask each lender how much rate one point buys and compare.

Temporary buydowns (2-1 and 3-2-1)

A temporary buydown lowers your rate for the first year or years, and the cost is paid upfront into an account that covers the difference. In a 2-1 buydown, the rate is 2 percentage points below the note rate in year 1 and 1 point below in year 2. From year 3 you pay the full note rate for the rest of the loan.

The total cost, about $11,500, equals the payment savings, so a buydown you pay for yourself does not save money. It only shifts payments earlier. It helps when the seller or builder pays, or when you need lower payments for two years.

Fannie Mae rules for temporary buydowns

• The rate reduction cannot exceed 3 percentage points, and the buydown period cannot exceed 3 years.
• The rate can rise by no more than 1 point in each year.
• You must qualify at the full note rate, not the bought-down rate.
• The funds must be held in a custodial bank account.
• Investment properties and cash-out refinances are not eligible.

Seller-paid points and concessions

Sellers can pay for your points or a buydown as a concession, but lenders cap the total. For Fannie Mae loans, interested party contributions, which include a buydown funded by the seller, are limited by your loan-to-value ratio:

Check your own room with the seller concessions calculator. If a seller offers a credit, compare using it for permanent points versus a temporary buydown with the 2-1 buydown calculator.

Are points tax deductible?

Points are treated as prepaid mortgage interest, which you can deduct only if you itemize. IRS Publication 936 lets you deduct points in full in the year you pay them when all of these are true, including that:

• The loan is secured by your main home and used to buy or build it.
• Paying points is an established practice in your area, and the amount is not more than is generally charged there.
• The points were not paid in place of fees normally listed separately, such as appraisal, title or attorney fees.
• The cash you provided at or before closing (plus any seller-paid points) is at least equal to the points, and you did not borrow it from the lender or broker.
• The points are a percentage of the principal and clearly shown as points on the settlement statement.

Other cases are deducted over the life of the loan: points on a refinance (except the part used to substantially improve your main home) and points on a second-home loan. If the seller pays your points, you can generally deduct them under the same tests, but you must reduce your home’s cost basis by that amount. Ask a tax professional how this applies to you.

Bottom line

• Pay points only if you are confident you will keep the loan past the break-even month.
• Paying for a 2-1 buydown yourself does not save money; it is most useful when the seller pays.
• Compare offers on the same day with the same lock, using the mortgage offer comparison calculator.
• Read your Loan Estimate line by line: see how to read your Loan Estimate and Closing Disclosure.

Thinking about an ARM instead? A lower starting rate can do what points do without the upfront cost, with different risks. See fixed vs adjustable-rate mortgages. This guide is general information, not tax or financial advice.