Should You Pay Discount Mortgage Points?
Should you pay discount points when you get a mortgage? To answer that question, you have to guess whether you’ll keep the mortgage past the break-even point – the time when your accumulated monthly savings exceed the amount you paid in points.
Lenders say that a lot of customers – especially first-time home buyers – don’t understand the concept of discount points and feel reluctant to ask. One discount point is an upfront payment of 1 percent of the loan amount, paid at closing. You receive a reduction in the interest rate in exchange for paying discount points. You end up with a lower monthly mortgage payment.
Discount points are based on the loan size, not the purchase price. If you borrowed $200,000 to buy a $300,000 house, one point would cost 1 percent of the loan amount, or $2,000. Two points would cost $4,000. Paying discount points doesn’t reduce the amount borrowed.
As a rule of thumb, the mortgage’s interest rate is reduced by a quarter of a percentage point for every discount point you pay. That’s just a rough guide, though; the actual amount of the discount varies by lender and can fluctuate in response to movements in the bond markets. One day a lender might drop the interest rate by a quarter-point in exchange for a discount point; the next day, the same rate reduction might cost only half a point. Most lenders give the option of paying anywhere from half a point to four discount points or even more.
To find out whether you’ll hold the mortgage past the break-even point, you must have a notion of how long you will keep the mortgage. If you plan to sell the house or refinance within two years, it probably doesn’t make sense to pay discount points. On the other hand, if you plan to keep the mortgage for 10 years or more, you’ll save money in the long run by paying points.
The time in between can be trickier. One way to figure it out is to ask your mortgage lender to prepare a chart outlining some of your options.
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