What Are Mortgage Discount Points?
As Investopedia explains, mortgage discount points are a form of prepaid mortgage interest. In fact, purchasing mortgage discount points from a lender is sometimes called “buying down the interest rate.” Each point typically costs 1 percent of the loan amount. What are mortgage discount points worth? Buying a point generally shaves about 0.25 percent off the interest rate. Some lenders will also allow you to purchase partial points.
The Different Types of Mortgage Points
When dealing with mortgage points, you have to pay careful attention because there are two different types:
- Origination Mortgage Points: These are mandatory fees that cover your lender’s expenses for processing your home loan. They’re paid at closing.
- Discount Mortgage Points: These are optional. They offer a way to reduce your interest rate, which can lower both your monthly mortgage payment and the total amount of interest that you’ll pay over the course of your home loan if you repay it as scheduled. They’re also paid for at closing, but they can sometimes be rolled into the loan balance. Because they’re a form of mortgage interest, you may also be able to deduct them at tax time if you itemize.
When Are Mortgage Discount Points Worth It?
There’s a cost to be paid for mortgage discount points, so every homebuyer has to decide if it’s worth paying. Forbes indicates several scenarios where it might be worth it:
- Your credit score prevents you from qualifying for the best interest rates.
- You need a lower monthly mortgage payment.
- You want a tax deduction and have funds available to buy mortgage discount points.
- You’re planning to stay in the home for a lengthy period, so you should break even on the cost of the mortgage discount points.
Calculating the Break-Even Point of Mortgage Points
If you can afford to buy mortgage discount points and would like a lower interest rate, then time may be the deciding factor in your decision to buy points. Are you planning to keep your mortgage long enough to break even on the purchase of the points? Each month that you remain in the home with the same mortgage allows you to enjoy savings as a result of your purchase of discount mortgage points. Over the years, those savings add up. Eventually, they’ll equal the fee that you paid for your points. That’s when you hit the break-even point. After that, you’re ahead of the game. However, if you sell or refinance before the break-even point, then you’ll lose the money that you paid for the discount points.
The timing of the break-even point for discount mortgage point purchases varies depending on the number of points purchased, loan size, interest rate, and term. It’s normally several years. Running the numbers is a smart way to help you decide if purchasing points is a good move in your particular situation. PrimeLending has an Impact of Discount Points Calculator that makes it easy.
Should I Pay for Mortgage Discount Points?
Mortgage discount points are an optional purchase, but they aren’t right for every homebuyer. According to SmartAsset, buyers who can’t afford hefty upfront payments at closing are likely better off accepting their current interest rate and waiting to refinance at a later date. Meanwhile, buyers who do have the funds available should run the numbers carefully to see when the break-even point would be. Then, they can consider their plans and weigh their options. Ultimately, they may decide to buy mortgage discount points, make a larger down payment, keep a larger reserve, or make some other investment.