Buying mortgage discount points vs. a larger down payment
Quick insights
- A larger down payment may lower your loan amount, monthly payments and eliminate the need for private mortgage insurance (PMI).
- Buying mortgage points could lower your interest rate and save you on interest over time but requires higher upfront costs.
- The right option depends on your long-term plans, budget at closing and how soon you want to see savings.
When you’re preparing to buy a home, you’ll face an important question: Should you put more money into your down payment, or use some cash to buy mortgage points and lower your interest rate? While both options may help reduce your overall loan costs, they do so in different ways, and the better fit depends on your financial priorities.
Let’s review how each option (or neither of them) could impact your home purchase, mortgage terms and long-term costs. Understanding your options can help you make a confident, informed decision.
What are mortgage points?
Mortgage points are optional upfront fees paid at closing to lower your mortgage interest rate. One point usually equals 1% of the total loan amount and could reduce the interest rate by a small percentage, such as .125% (1/8th) or 0.25% (1/4th). This approach, typically referred to as “buying down the rate,” could save you money over time, especially if you stay in the home for years to come.
Keep in mind that buying points will raise your upfront closing costs, which are separate from the money you put down up front.
What is a down payment?
A down payment is the portion of a home’s purchase price paid upfront by the homebuyer, generally expressed as a percentage of the total purchase price. For example, a 10% down payment on a $500,000 home would be $50,000. The rest can be financed through a mortgage loan. A larger down payment could potentially reduce your monthly payments, lower your interest costs, and may even help you avoid private mortgage insurance (PMI) on conventional loans. It’s to balance upfront affordability with long-term savings.
Mortgage points vs. larger down payment
When deciding how money can be allocated up front for a home purchase, these two possibilities are prominent.
Mortgage points
- Paid to the loan provider at closing to lower your interest rate
- Usually cost 1% of the loan amount per point
- Adds to your upfront closing costs
- Suited for homebuyers who plan to stay in the home long term
Down payment
- Paid upfront toward the purchase price of the home
- Directly lowers the total amount you need to borrow
- May reduce your monthly mortgage payment immediately
- Suited for homebuyers who want to reduce their loan balance and monthly payments from the start
Pros and cons of buying mortgage points
Buying mortgage points can lower your interest rate and monthly payment, but whether it’s the right move depends on your budget, goals and how long you plan to keep the loan.
Pros
- Lower interest rate: A lower mortgage rate could potentially save thousands of dollars in interest over time.
- Smaller monthly payments: A reduced rate can lead to lower monthly costs, which may improve affordability.
- Long-term savings: If you stay in the home long enough to break even, buying mortgage points could lead to meaningful interest savings.
- Possible tax benefits: Mortgage points may be deductible as mortgage interest in some cases. Consult with a tax professional for guidance.
Cons
- Higher upfront costs: Points increase your closing costs, which may require careful budgeting.
- Delayed savings: It may take years to recoup the cost through monthly savings, especially with a small loan or short stay.
- Less cash for other needs: Using funds for points means you may have less available for your down payment or emergency savings.
- Savings not guaranteed: If you sell or refinance at a certain time, you may not break even.
Pros and cons of putting more money down
Putting as much money down on a home purchase as you can reduces your loan amount and monthly payments; however, this may not be a good use of extra cash depending on your situation and goals.
Pros
- Smaller loan amount: A larger down payment directly lowers how much you need to borrow.
- Lower monthly payments: A lower loan principal may reduce monthly payments.
- Could help avoid PMI: Putting at least 20% on conventional loans usually eliminates the need for private mortgage insurance (PMI).
- Better loan terms: A higher down payment could improve your loan-to-value (LTV) ratio, which may help you qualify for better rates.
- More equity upfront: You start with more ownership in the home, which may offer more financial flexibility down the line.
Cons
- Ties up your cash: A larger down payment could leave you with less savings for emergencies, moving costs or home repairs.
- Opportunity cost: Money used for a down payment could possibly be invested elsewhere or used to pay down higher-interest debt.
- Longer time to save: It may take longer to save for a large down payment, which could delay your homebuying timeline.
Break-even analysis example
Buying mortgage points can be beneficial if you expect to stay in the home long enough to recoup the upfront cost, the “break-even period.” For example, if one-point costs $4,000 and lowers your monthly payment by $60, breaking even would take around 67 months (about 5.5 years). If you plan to move or refinance before then, the upfront cost may not be worth it.
In general:
- If you’re putting less than 20% down, increasing your down payment can lower your loan amount and avoid PMI.
- If you’re already putting down 20% or more, using any extra funds toward buying points can save money if you live in the home long-term.
You can use a mortgage discount points calculator to enter different mortgage point scenarios to see how they will impact the cost of your loan. A Home Lending Advisor can help you review your options and decide whether putting more toward your down payment or buying discount points makes the most sense for your financial goals.
Mortgage points, larger down payment or neither? How to spend upfront money
Only you can decide the amount of extra money you can (or want to) put down upfront when buying a home. A vital part of the decision could be how long you plan to stay in the home and how quickly you want to see savings. When buying points, the break-even point is an important timeline. When putting extra money down, there are pros and cons.
New homeowners might also catch the renovation bug and want money to make a new house their own in the first year or two. Certain repairs can also be costly and unpredictable, so a financial safety net can be helpful for new homeowners. Depending on your budget for upfront homebuying costs and the new mortgage payment, you may want to skip buying points or putting more money down altogether.
In summary
Both buying mortgage points and making a larger down payment can help lower the long-term cost of owning a home, but in different ways. A larger down payment reduces your loan amount upfront, lowering your monthly payments and potentially helping you avoid PMI. On the other hand, mortgage points may lower your interest rate and save more over time, especially if you plan on living in the home for several years.
The right option depends on your financial goals, how long you expect to keep the mortgage and how much cash you have available at closing.
