3–7 yr · The window most loans actually end in
Points are a bet on how long you stay
The arithmetic takes three lines. The hard part is that the clock stops when the loan ends, and a loan ends when you refinance, not only when you move.
A discount point costs one per cent of the loan amount and buys a lower rate. That is the whole product. Everything difficult about it sits in a single question that has nothing to do with mortgages: how long are you going to keep this loan?
The arithmetic, and why it is only three lines
Take what the point costs today. Take what it removes from the monthly payment. Divide the first by the second and you have the number of months before you are ahead. Sell or refinance before that month and the point lost money. Stay past it and every month after it is profit. There is no fourth line.
| Cost of one point | If it removes this from the payment | Break-even |
|---|---|---|
| $3,000 | $40 a month | 75 months |
| $3,000 | $55 a month | 55 months |
| $3,000 | $70 a month | 43 months |
| $3,000 | $85 a month | 36 months |
Notice the spread. The same point, on the same loan, has a break-even anywhere from three years to more than six, depending only on what the pricing gives you that morning. That is why a lender who says points are worth it without asking a single question about your plans is not doing arithmetic. They are doing something else.
Two corrections the simple version leaves out
The three-line version is close enough to decide most cases, but it is worth knowing which way it is wrong, and it is wrong in both directions at once.
- It understates the benefit slightly. A lower rate does not only cut the payment, it also retires principal a little faster, so on the day you sell your balance is lower than it would otherwise have been. The true break-even arrives a little earlier than the division suggests.
- It ignores what the cash could have done. Money handed over at closing is not in your reserves and not invested. If paying points empties the account that was going to cover a new roof, the break-even on paper is not the break-even you live in.
- It assumes the payment saving is constant, which on a fixed-rate loan it is. On an adjustable loan it is only true until the first adjustment, and buying points on a rate that is going to move is a much weaker bet.
For a fixed-rate loan the first two corrections pull in opposite directions and, for most files, roughly cancel. Use the simple number. Treat it as approximate rather than exact, and do not let anyone sell you a decision on the strength of the third decimal place.
The horizon is the loan, not the house
This is the part that is nearly always got wrong. The break-even clock stops when the loan ends, and a loan ends when you sell or when you refinance. You can stay in the same house for twenty years and still lose money on points, because you refinanced in year four and the points went with the old loan.
So buying points is, among other things, a bet against your own future refinancing. If rates are high relative to where you think they are going, the loan you are taking out is the one you are most likely to replace, and the point is being spent on a loan with a short life. If there is not much left to refinance towards, the loan is likely to be a long one, and the point has the years it needs to pay back.
Lender credits are the same lever, pulled the other way
You can also take a higher rate in exchange for a credit towards your closing costs. That is the identical trade in reverse: you are paid today and you pay monthly for it afterwards. It has a break-even too, calculated the same way, and if your horizon is short the credit is often the better side of the deal. A lender who offers you points but never mentions credits is showing you one half of a lever.
Make sure it is a discount point at all
The word point is used for two entirely different things. A discount point is a prepayment of interest that buys a lower rate. An origination point is a fee for making the loan, and it buys nothing at all. Both appear on the second page of the Loan Estimate, in different places, and a loan can carry both at once. If a point is not attached to a visibly lower rate on a document, it is not a discount point.
What to ask for
- The same loan quoted at least three ways on the same day: at zero points, at one point, and with a lender credit. Pricing moves daily, so quotes gathered on different days are not comparable and comparing them is worse than not comparing at all.
- The break-even in months for each option, worked out by the lender while you watch, so you can see which monthly saving they are claiming.
- Your own honest horizon. Not how long you intend to live in the house, but how long you expect to keep this loan.
- Whether the cash would do more as down payment instead. On a low-down-payment conventional loan, moving from just under a mortgage insurance threshold to just over it can be worth more than any point.
Tax treatment is a separate question and it is not a lender’s to answer. Points paid on the purchase of a principal residence may be deductible in the year they are paid, if a set of conditions is met. Points paid on a refinance are generally spread across the life of the loan instead. Which of those applies to you depends on your own return, so ask the person whose job that is.
Points are not expensive or cheap. They are early or late, and the only person who knows which is you.
This is a design demonstration and an explanation of published rules, not advice about your file. Nothing here is an offer or a commitment to lend. See thedisclosures.