Mortgage discount points: What are they and when are they a good idea? Points are quoted as a percentage of the cost of your mortgage. Each point you purchase lowers your interest rate by a set amount that varies by lender. Buying points makes financial sense when you stay in the home long enough, because over time you can save more in interest than you paid for the point.
How do mortgage discount points work? During your mortgage loan closing, your lender may offer you the opportunity to lower your interest rate by purchasing mortgage points. Each mortgage point costs 1% of the amount you borrow. If you borrow $100,000, one point costs $1,000. If you borrow $200,000, it will cost you $2,000. This fee is paid at closing, so the points add to the initial cost of buying a home. You can even buy just part of a point, like ½ point for $500 or ¾ point for $750 on a $100,000 loan. Each point—or part of a point—reduces the interest rate to a specific amount that varies by lender. For example, if your lender offers you a 0.25% interest rate reduction for each point you purchase on a loan with an initial interest rate of 4.25%, purchasing one point would reduce your interest rate to 4%. Points are listed on the Loan Estimate as well as on Page 2, Section A, of the Closing Statement. The items listed on those documents must be related to a reduction in your mortgage interest rate. Note that some lenders also refer to other fees and initial costs as points, but the points that appear on the loan estimate and closing statement should be discount points related to a discounted interest rate.
Should I buy mortgage discount points? The decision to purchase discount points largely depends on how long you intend to stay in the home. Discount points can cost thousands of dollars up front, adding to the cost of the mortgage. But as the interest rate goes down, the money saved on monthly payments can eventually offset the initial cost. Once the cost of the points you paid at closing is covered, any additional savings from a lower interest rate is additional money in your pocket. To find out if purchasing points is right for you, estimate how long it will take to cover the initial cost based on what you can save.
Suppose you want to borrow $200,000 to buy a house and the initial cost of one point is $2,000. Divide the $2,000 by the amount saved each month from the interest rate reduction to see how many monthly payments it will take to break even. Since the actual amount you save varies based on the lender, you'll need to figure out what your interest rate and monthly payment would be, both with and without points. Let's see an example.
let's do the math Let's take the example of the $200,000 you want to borrow to buy a house. If you are approved for a 30-year 4.25% mortgage, your monthly principal and interest payment would be $984.
One Point : If you were to buy one point at a 0.25% discount, you would lower your interest rate to 4%. o Monthly savings : Your monthly premium would be reduced from $984 to $955, saving $29 per month. o Break -even point : Divide the cost of the point by your monthly savings ($2,000 / $29 = 69 months). It would take him nearly six years to recoup the money he spent up front to buy the point.
Four Points – If you bought four points to get a 1% discount, it would reduce your rate to 3.25%. o Monthly savings: Your monthly premium would be reduced from $984 to $870, saving $114 per month. o Break -even point : Divide the cost of the points by your monthly savings ($8,000 / $114 = 70 months). Once again, it would take him almost six years to break even.
In these examples, you would have to stay in your home for 69 months or more to cover the cost of the points you purchase and start saving money on your mortgage. It is difficult to predict how long you will stay in your home. After all, things happen in life. But try to make a realistic estimate to give yourself the best chance of making the right decision when purchasing points.
Compare mortgage loan offers A good understanding of how discount points work is one of several important factors in your decision. It's also important to know how they work when comparing loan rate offers . That's because if two lenders offer you the same interest rate, but one charges you a point and the other doesn't, the lender that doesn't charge you the point is the one that makes you the best offer. When shopping for loans, if two lenders offer you a $200,000 fixed rate loan at 4.25%, but one of them charges you a point for that interest rate, you would be paying $2,000 more up front with that lender to get the same rate. interest from the other lender for free. That's why it's so important to carefully compare and understand loan terms before deciding on a lender's offer.
In summary Mortgage discount points allow you to lower your interest rate when you prepay interest. Each point that is purchased is priced at 1% of the amount that is borrowed. Buying points can save you money in interest over time, but only if you stay in the home long enough for the discounted interest rate to offset the initial cost of the points. Do the math to see if buying points is the right option for you when you get a home loan.