Mortgage Points and Lender Credits

Your lender offers you the option to buy mortgage discount points. You are not sure if you should. The pitch sounds reasonable -- pay more upfront, lower your rate forever. But whether that trade makes sense depends entirely on one number: how long you plan to stay in the home. Buying down a mortgage rate is not inherently good or bad. It is a break-even calculation, and once you see the math, you can make the call in about thirty seconds.

What a Mortgage Point Actually Is

One mortgage point equals 1 percent of the loan amount. On a $400,000 loan, one point costs $4,000 and is paid at closing. In exchange, the lender permanently reduces your interest rate -- typically by about 0.25 percent per point, though the exact reduction varies by lender and market.

Paying one point on a $400,000 loan might drop your rate from 7.0% to 6.75%. That moves your monthly payment from $2,661 to $2,594. You save $67 per month. Whether $4,000 today is worth $67 per month forever depends on how long "forever" actually is for you.

Discount Points Are Not the Same as Origination Points

Lenders sometimes use "points" to describe two very different things. Discount points are optional fees you pay to buy down your rate. Origination points are a lender fee for processing the loan -- not optional, and they do not reduce your rate.

When a lender quotes you an offer with "points," ask directly: are these discount points that reduce my rate, or origination points that are just a fee? The answer changes the math entirely.

The Only Calculation That Matters

Break-even is straightforward. Take the cost of the points and divide by the monthly savings:

• You pay 1 point: $4,000 at closing
• Rate drops from 7.0% to 6.75% on a $400,000 loan
• Monthly payment at 7.0% is $2,661; at 6.75% it is $2,594
• Monthly savings: $67
• Break-even: $4,000 divided by $67 equals roughly 60 months, or 5 years

Sell or refinance before year five, and paying the point cost you money. Stay past year five, and every month after that break-even is pure savings. The math does not change. Only your timeline changes.

Lender Credits: The Same Trade in Reverse

Lender credits flip the points equation. Instead of you paying money upfront to lower your rate, the lender gives you money at closing -- say $3,000 -- to reduce your out-of-pocket costs. In exchange, your rate goes up, perhaps from 6.75% to 7.0%.

You spend less at closing but pay more every month for as long as you hold the loan. The lender is not offering you free money. They are offering cash now in exchange for a higher rate later.

When Taking Lender Credits Is the Right Move

• You plan to sell or refinance within three to five years, so the higher rate hurts you for a limited time
• You are short on cash at closing and need to reduce what you bring to the table
• You expect rates to fall, making a future refinance likely -- the higher rate becomes temporary

When Buying Points Makes Financial Sense

• You plan to keep this loan for seven or more years, well past the break-even point
• You have the cash available and want to reduce your monthly payment permanently
• You are buying a home you intend to hold long-term and want to lock in the lowest possible rate