Mortgage Discount Points: Break-Even Formulas, Buydowns & Financial Trade-Offs
Mortgage discount points represent prepaid interest. By paying an upfront fee at closing (typically 1% of the loan amount per point), borrowers can permanently lower their interest rate by 0.25% (25 basis points). Deciding whether to buy points depends strictly on your break-even horizon and the probability of refinancing or moving before that date.
format_list_bulleted Table of Contents
1. How Discount Points Work (Cost vs Rate Reduction)
1 Point = 1.0% of the loan principal (not the purchase price). For a $500,000 loan, 1 point costs $5,000. In exchange, lenders typically reduce the nominal interest rate by 0.25%.
2. The Break-Even Formula & Worked Example ($400k Loan)
The mathematical break-even point in months is calculated as:
| Scenario ($400k 30-Yr Loan) | Interest Rate | Upfront Cost | Monthly P&I | Break-Even Point |
|---|---|---|---|---|
| Zero Points (Par Rate) | 6.75% | $0 | $2,594 / mo | Baseline |
| 1 Point (0.25% Buydown) | 6.50% | $4,000 | $2,528 / mo | 61 Months (5.1 Years) |
| 2 Points (0.50% Buydown) | 6.25% | $8,000 | $2,463 / mo | 61 Months (5.1 Years) |
3. Permanent Buydowns vs Temporary 2-1 / 3-2-1 Buydowns
Builders and sellers frequently offer Temporary 2-1 Buydowns as purchase concessions. In a 2-1 buydown:
- Year 1: Interest rate is 2% below note rate (e.g., 4.75% instead of 6.75%).
- Year 2: Interest rate is 1% below note rate (5.75%).
- Year 3 through 30: Returns to the permanent note rate (6.75%).
4. IRS Tax Deductibility of Mortgage Points
Under IRS Publication 936, points paid on a primary residence purchase can generally be deducted in full in the year paid if you itemize deductions on Schedule A. For refinances, points must be amortized evenly over the full life of the loan (e.g., deducting 1/30th annually on a 30-year refinance).
5. When Buying Points is a Costly Mistake
- High Interest Rate Cycles: If rates are historically elevated and expected to drop, paying $4,000+ for points is wasted because you will likely refinance before reaching the 5-year break-even.
- Limited Cash Reserves: Depleting your emergency fund to buy points leaves you vulnerable to home repair emergencies.
- Short Planned Tenure: If you plan to upgrade or relocate within 4 years, avoid points completely.