Are Mortgage Discount Points Worth It

Example: How Discount Points Work

Say you arrange a 30-year fixed-rate mortgage in the amount of $200,000 with a 5% interest rate. You want an interest rate of 4.5%, so you pay $4,000 for discount points . Paying for those two points reduces your rate by .5% and brings the rate down to your desired 4.5%. That $4,000 you pay at closing lowers your monthly mortgage payment from $1,073.64 to $1,013.37, which saves you $60.27 each month. You get lower mortgage payments each month, but you pay more at closing. That’s the tradeoff.

On the flip side, “negative” discount points, sometimes called “rebates” or “yield spread premiums,” reduce the amount of cash you need to pay at closing. But then you have to pay a higher interest rate.

Another kind of mortgage points are “origination points” These points don’t have anything to do with the loan’s interest rate. Instead, origination points are fees you pay to the lender in exchange for providing and processing the loan. Another name for origination points is “origination fees.”

Example Of How Mortgage Points Can Cut Interest Costs

If you can afford to buy discount points on top of the down payment and closing costs, you will lower your monthly mortgage payments and could save lots of money. The key is staying in the home long enough to recoup the prepaid interest. If you sell the home after only a few years, or refinance the mortgage or pay it off, buying discount points could be a money-loser.

Here is an example of how discount points can reduce costs on a 30-year, fixed-rate mortgage in the amount of $200,000:

In this example, the borrower bought two discount points, with each costing 1 percent of the loan principal, or $2,000. By buying two points for $4,000 upfront, the borrowers interest rate shrank to 3.5 percent, lowering their monthly payment by $56, and saving them $20,680 in interest over the life of the loan.

Are Mortgage Discount Points Worth Buying

Because purchasing discount points lowers your monthly payments, but costs you more when you take out the loan, a good place to begin thinking about whether the expense is worth it is to determine when you’ll break even. You should also think about other factors before buying points on a mortgage, like how much they’ll save you in the long run. Here are some issues to consider.

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How Do Mortgage Points Work

Paying discount points reduces the interest rate and therefore the monthly payments. Your monthly savings depends on the interest rate, the amount borrowed and the loans term .

The table below illustrates the monthly savings from paying one or two discount points on a $200,000 mortgage with a base interest rate of 5% and a 30-year term. Without discount points, the monthly principal and interest is $1,073.64. The monthly payments are lower after reducing the rate by paying one or two basis points.

When To Buy Mortgage Points

Buying mortgage points might make sense if any of the following situations apply to you:

• You want to stay in your home for a long time. The longer you stay in your home, the more it makes sense to invest in points and a lower mortgage rate. If youre sure youll have the same mortgage for the long haul, mortgage points can lessen the overall cost of the loan. The longer you stick with the same loan, the more money youll save with discount points.

• Youve determined when the breakeven point is. Do some math to figure out when the upfront cost of the points will be eclipsed by the lower mortgage payments. If the timing is right and you know you wont move or refinance before you hit the breakeven point, you should consider buying points.

How do you calculate that breakeven point, you ask? Lets run through a quick example using the numbers referenced earlier.

If you have a $200,000 loan amount, going from a 4.125% interest rate to a 3.75% interest rate saves you $43.07 per month. As mentioned earlier, the cost of 1.75 points on a $200,000 loan amount is $3,500. If you divide the upfront cost of the points by your monthly savings, youll find that your breakeven point is about 82 months , which is equal to roughly 6 years and 10 months. So, if you plan to stay in your house for longer than that amount of time and pay off your loan according to the original schedule, it makes sense to buy the points because youll save money in the long run.

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Are Discount Points Worth It

It may make sense to pay discount points when youre buying a long-term investment property or a home you plan to hold for many years, says Ann Thompson, a retail sales executive at Bank of America, because youll save after breaking even.

Heres an example from Thompson to help demonstrate how long it can take to benefit from buying a point. Say youre taking out a $400,000 loan. One discount point would cost $4,000 paid at closing assume you can afford that on top of your other closing costs.

Based on mortgage rates the day she was interviewed, Thompson said buying a point would save roughly $57 a month on that $400,000 mortgage. By dividing the cost of the point by the monthly cost , you determine how many months it would take you to make up the cost of buying the point. In this example, its about 70 months, or almost six years.

That means if you planned to stay in the home for six years, youd break even, and any longer than that, youd save money. But if you moved out before then, youd have lost money by buying points.

When Will You Break Even After Buying Mortgage Points

To determine if it’s a good idea to pay for points, compare your cost in points with the amount you’ll save with a lower interest rate and see how long it will take you to make your money back. If you can afford to pay for points, then the decision more or less boils down to whether you will keep the mortgage past the time when you break even. After you break even, you’ll start to save money. The break-even point varies, depending on your loan size, interest rate, and term.

Example. As in the example above, let’s say you get a 30-year loan of $300,000 with a 3% fixed interest rate. Your monthly payment will be $1,265. However, if you buy one point by paying $3,000, and your rate goes down to 2.75%, the monthly payment becomes $1,225. So, divide the cost of the point by the difference between the monthly payments. So, $3,000 divided by $40 is 75, which means the break-even point is about 75 monthsmeaning you’d have to stay in the home for 75 months to make it worth buying the point.

As you can see, the longer you live in the property and make payments on the mortgage, the better off you’ll be paying for points upfront to get a lower interest rate. But if you think you’ll want to sell or refinance your home within a couple of years , you’ll probably want to get a loan with few or no points. Check the numbers carefully before you pay points on a loan because you might not recoup the cost if you move or refinance within a few years.

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Should You Buy Points

If you can afford them, then the decision whether to pay points comes down to whether you will keep the mortgage past the break-even point.

The concept of the break-even point is simple: When the accumulated monthly savings equal the upfront fee, youve hit the break-even point. After that, you come out ahead. But if you sell the home or refinance the mortgage before hitting break-even, you lose money on the discount points you paid.

The break-even point varies, depending on loan size, interest rate and term. Its usually more than just a few years. Once you guess how long youll live in the home, you can calculate when youll break even.

Should You Pay For Mortgage Points

It seems odd to say, but buying mortgage points to lower your interest rate could actually be a complete rip off. Say what? How can a lower interest rate be a bad deal?

For starters, it could be years before you really save any money on interest because of your mortgage points. To see what this would look like, youd first need to calculate whats known as your break-even point.

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Should I Pay For Mortgage Discount Points

Paying discount points to get a lower interest rate can be a great strategy. Lowering your rate even just 25 basis points could save you tens of thousands over the life of the loan.

But theres a catch. You have to keep your mortgage long enough for the monthly savings to cancel out the cost of buying points.

Luckily, the math is simple you can find out if points are worth it in just a few minutes. At todays low rates, there are great deals to be had with or without discount points.

• Should you buy points?

Can I Get The Interest Rate I Want Without Buying Points

Your credit history has a direct impact on the interest rate the lender will offer you. If you have low credit scores, the lender will likely give you a higher interest rate than what’s available to those with good credit. So, if your aren’t good, it might make financial sense to pay points for a lower rate after considering all other factors. Or you might consider taking steps to improve your credit before you apply for a mortgage loan.

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How We Got Here

To use the Should I buy points? mortgage calculator, type your information into these fields:

• Desired loan amount

• Interest rate without points

• Number of points

• Interest rate with points This shows what your rate would be if you paid for points. In general, lenders drop the interest rate by a quarter of a percentage point for each point purchased, up to a limit. But maybe a lender has offered you a rate thats different for buying this number of points. If so, type in that rate to ensure the accuracy of your results.

How Much Does One Mortgage Point Reduce The Rate

When you buy one discount point, youll pay a fee of 1% of the mortgage amount. As a result, the lender typically cuts the interest rate by 0.25%.

But one point can reduce the rate more or less than that. Theres no set amount for how much a discount point will reduce the rate. The effect of a discount point varies by the lender, type of loan and prevailing rates, as mortgage rates fluctuate daily.

Buying points doesnt always mean paying exactly 1% of the loan amount. For example, you might be able to pay half a point, or 0.5% of the loan amount. That typically would reduce the interest rate by 0.125%. Or you might be given the option of paying one-and-a-half points or two points to cut the interest rate more.

How Much Does A Discount Point Lower My Rate

Typically, one point lowers your interest rate by about a quarter of a percent. But that can vary by lender and situation.

The amount you can lower your interest rate will depend on:

• Your mortgage lender
• Your loan amount
• The number of points you purchase

For example, say you borrow $200,000 at a fixed interest rate of 3.0%. If you pay $2,000 upfront for one discount point, you may be able to buy your rate down to 2.75%, or 25 basis points. That would drop your payment by nearly $27 per month, notes Chuck Meier, senior vice president and mortgage sales director at Sunrise Banks.

However, he continues, your breakeven point would be 75 months to recoup the cost of the point you purchased, which would take just over six years.

In other words, buying mortgage discount points may or may not be worth it based on your financial situation and timeline.

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How Much Do They Cost

Points cost 1% of the balance of the loan. If a borrower buys 2 points on a $200,000 home loan then the cost of points will be 2% of $200,000, or $4,000.

Each lender is unique in terms of how much of a discount the points buy, but typically the following are fairly common across the industry.

Fixed-Rate Mortgage Discount Points

Each point lowers the APR on the loan by 1/8 to 1/4 of a percent for the duration of the loan. In most cases 1/4 of a percent is the default for fixed-rate loans.

Adjustable-Rate Mortgage Discount Points

Each point lowers the APR on the loan by 3/8 of a percent , though this discount only applies during the introductory loan period with the teaser-rate.

Cost of Discount Points

As mentioned above, each discount point costs 1% of the amount borrowed. Discount points can be paid for upfront, or in some cases, rolled into the loan.

Fractional Discount Points

Some lenders may offer loans with fractional discount points. In mortgage rate listing tables it is not uncommon to see a loan with 1.1 discount points.

Do You Want An Even Lower Mortgage Rate Pay Points

• You can obtain an even lower mortgage rate if you elect to pay points at closing
• They are a form of prepaid interest that reduce your interest expense on the loan
• Instead of paying more each month, you pay more upfront
• This will save you money over the life of the loan via reduced interest

Lets assume youre shopping for a $100,000 mortgage.

While mortgage rate shopping, youll probably pay the most attention to the big, glaring rate in front of you, such as 2.99%.

But if you look under that rate, or in the small, fine print, you should see more details about the rate, such as the fact that it requires you to pay two mortgage points!

In this case, those two points are mortgage discount points, which lower the rate to that amazingly low 2.99% you see advertised.

But those two points will cost you $2,000, using our $100,000 loan example, as each point is equal to one percent of the loan amount.

If were talking about a larger loan amount, such as $500,000, its all of a sudden $10,000. Ouch!

Assuming you dont want to pay those two points, your actual mortgage rate will probably be markedly higher, perhaps 3.5% instead.

And the bank or lender may inform you that you have to pay points to get that low, advertised interest rate on your mortgage.

Its kind of like a car lease where youre told payments are only $199 per month for 36 months, but it requires $2,500 cash at signing. Is it really just $199?

For How Many Years Will I Need This Mortgage

In addition to the cost considerations of paying discount points, theres the question of the value of paying mortgage discount points.

Paying a fee to lower your mortgage rates might make sense over a 5- or 10- or 30-year time window. But, if you plan to move within a few years or refinance your loan, youll likely never recoup your initial investment.

For example, if you are using a FHA loan to purchase your home and expect that rising home value will help you to refinance your FHA MIP away, it may be wasteful to pay discount points on your loan.

Should You Pay For Discount Points

The answer to that question requires an understanding of the mortgage payment structure. There are two primary factors to weigh when considering whether or not to pay for discount points. The first involves the length of time that you expect to live in the house. In general, the longer you plan to stay, the bigger your savings if you purchase discount points. Consider the following example for a 30-year loan:

• On a $100,000 mortgage with an interest rate of 3%, your monthly payment for principal and interest is $421 per month.
• With the purchase of three discount points, your interest rate would be 2.75%, and your monthly payment would be $382 per month.

Purchasing the three discount points would cost you $3,000 in exchange for a savings of $39 per month. You will need to keep the house for 76 months, or six years, to break even on the point purchase. Since a 30-year loan lasts 360 months, purchasing points is a wise move in this instance if you plan to live in your new home for a long time. If, on the other hand, you plan to stay for only a few years, you may wish to purchase fewer points or none at all. There are numerous calculators available on the internet to assist you in determining the appropriate amount of discount points to purchase based on the length of time you plan to own the home.

Using a mortgage calculator is a good resource to budget these costs.