Discount points are fees paid to your lender at closing that lower the interest rate on your mortgage. Learn when it makes sense to purchase discount points.
In exchange for purchasing discount points upfront, you’ll receive a lower interest rate and lower monthly payment over the life of the loan. When you’re paying a discount point, you are essentially paying part of your interest upfront. This lowers your interest payment because your lender receives the income in a lump sum at closing rather than collecting the interest as you make payments month to month.
One discount point equals 1% of the loan amount. For example, if you were taking out a loan for $100,000, one discount point would cost $1,000.
Typically, each discount point purchased would lower your interest rate by .25%. So for a 30-year loan, a 4.0% rate would be lowered to 3.75% if you purchase one discount point. As a reminder, points do not lower or change the amount you’re borrowing, only the interest rate. There is no requirement to pay discount points.
Should you pay discount points?
To find your break-even on paying points:
1. Calculate the amount of your monthly mortgage payment at the interest rate you will be charged if you do not pay points.
2. Calculate the amount of your monthly mortgage payment if you do pay points.
3. Deduct the lower payment from the higher payment to find the amount saved each month.
4. Divide the amount charged for points at closing by the monthly amount saved. The result is the number of months you must keep the loan to break-even on paying points.
Deciding to pay discount points is best determined by considering the length of time you plan to own the home. More benefits exist if you plan to own the home for a longer period of time. If you plan to move or refinance your home in the near future, discount points may not be right the path for you.
TINA: A lot of people do get confused with discount points, it’s basically what we allow you to buy down your interest rate with. Let’s say your loan amount is $200, one point of that is one percentage, which is $2,000 to buy down your interest rate to a rate that’s below par. It allows you to save more money on a monthly basis, but you do have to pay additional fees up front in order to get down to that lower interest rate.
GEORGE: If they come to me asking about discount points, I usually like to see the point paid. It’s prepaid interest. It lowers the mortgage rate and therefore, they get the deduction from the points first off and then what happens is the mortgage is lower for the life of the loan, so in the long run they can save quite a bit of money.
GEORGE: Sometimes I advise someone not to pay for the points if perhaps you’re going to stay in the house for a short time, and they know that. It may not be enough time for the points to amortize over the life of the loan, so they may not have a savings, but generally if they’re going to stay there for a few years it pays off to pay some points.