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Mortgage Discount Points: A Closer Look

man calculating numbers

When Stacey and Doug were shopping for a home loan, their Loan Officer mentioned the option of buying discount points in order to lower their rate. He explained that it might make sense for them since they planned on living in the home for a long time. The option of paying to get a lower rate intrigued them, but they were confused on whether the option was right for them. If you, like Stacey and Doug, could use a little more information on mortgage discount points, keep reading.

What Is It?

Mortgage points - they impact the loan and your pocket! But what are points when they pertain to a mortgage? Think of the points as a charge to buy down your interest rate.

Discount Points

If you want a lower rate than the par rate being offered, then you might want to pay discount points to obtain that desired rate. To put it simply, each point is a payment equal to 1% of the total amount that will be financed.

You should take into consideration that mortgage points are tax deductible. The points can be itemized as home mortgage interest on a Schedule A. If you have the money available to put down at closing and you plan on staying in your home, reducing the interest rate by paying points could be beneficial.

What It Looks Like

The true value of a point varies with the loan amount. Example: The higher the loan amount, the higher the value of the point. It is important to note that discount points are based on the loan itself, not on the purchase price.

1 point = Loan amount x 1%

Discount Points

The formula to calculate how much a discount point is going to cost you is a little bit different. Let's assume the par rate (the lowest rate you qualify for without a cost) is 4.125, but you are contemplating obtaining a 4% interest rate:

Discount Points

Is It Worth It?

To determine if discount points are right for you, the first thing you should ask yourself is "how long am I going to live in the home?" If you plan to sell the home or refinance within a couple of years, it would not make sense to pay discount points. On the other side of the coin, if you plan to stay in your home for a while buying discount points will save you money.

Your next question should be, "What is my break-even?" Asking your lender how much you would save per month by paying a certain number of discount points is the simplest way to calculate the break-even point.  For example, the discount point in the example above was purchased for $925 and let's says it hypothetically reduced the monthly payment by $15, to calculate the break-even point, you would then divide $925 by $15 for a break-even point of 61.66, divide that by 12, and the break-even for this example is roughly 5 years.

Bottom line is that decisions regarding purchasing discount point should be made consciously and strategically. It is a long term investment with long term return.

How low will your payment be?