Calculating Break Even for Mortgage Points
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Determining when mortgage points are financially beneficial requires calculating the break-even point where the cost of points equals the savings from a lower interest rate. This guide explains the process step-by-step, including formulas, examples, and key considerations.
What Are Mortgage Points?
Mortgage points are fees paid to the lender at closing, expressed as a percentage of the loan amount. Each point typically reduces the interest rate by a small amount, such as 0.25% per point. For example, paying 1 point on a $200,000 loan reduces the rate by 0.25% and costs $2,000.
Key Points
- 1 point = 1% of the loan amount
- Typical reduction per point: 0.25% to 0.50% interest rate
- Points are paid upfront but can save money over the loan term
How to Calculate Break Even
The break-even point for mortgage points is the number of months required for the savings from a lower interest rate to equal the cost of the points. The formula is:
Break Even Formula
Break Even (months) = (Points Cost) / (Monthly Savings from Lower Rate)
Where Monthly Savings = (Original Interest Rate - New Interest Rate) × Loan Amount / 12
To calculate:
- Determine the cost of the points (Points × Loan Amount)
- Calculate the monthly savings from the interest rate reduction
- Divide the points cost by the monthly savings to find the break-even period
Example Scenario
Loan Amount: $200,000
Original Interest Rate: 6.5%
Points Purchased: 1 point (0.25% rate reduction)
Points Cost: $2,000
Example Calculation
Using the example scenario:
- New Interest Rate = 6.5% - 0.25% = 6.25%
- Monthly Savings = ($200,000 × (6.5% - 6.25%) / 12) = $208.33
- Break Even = $2,000 / $208.33 ≈ 9.59 months
This means buying 1 point on a $200,000 loan at 6.5% will break even in about 9.6 months if the rate reduces by 0.25%.
| Term | Total Interest Paid | Points Cost | Net Savings |
|---|---|---|---|
| 15 years | $126,000 | $2,000 | $124,000 |
| 30 years | $252,000 | $2,000 | $250,000 |
Factors to Consider
When evaluating mortgage points, consider these factors:
- Loan Term: Shorter terms benefit more from points due to compounding interest
- Interest Rate Reduction: Larger reductions (e.g., 0.50% per point) increase savings
- Loan Amount: Higher loan amounts mean larger point costs and savings
- Closing Costs: Points are one of many closing costs; compare total savings
- Alternative Savings: Points may not be the best option if you can save for a down payment or reduce other costs
When Points Make Sense
- When interest rates are expected to rise
- For first-time buyers with limited savings
- When the break-even period is within your expected homeownership duration
Frequently Asked Questions
How do mortgage points affect my interest rate?
Each point typically reduces your interest rate by 0.25% to 0.50%. For example, 2 points on a $200,000 loan might reduce the rate by 0.50% (1% total).
Are mortgage points worth it?
Points may be worth it if the break-even period is within your homeownership plans. Use the calculator to compare savings versus costs.
How do I calculate the cost of mortgage points?
Multiply the number of points by the loan amount. For example, 1 point on a $200,000 loan costs $2,000.
Can I get a better deal on points?
Some lenders offer discounts or promotions on points. Compare offers from multiple lenders to find the best rate.