Better to pay in points for a lower mortgage rate?



Is it worth paying for mortgage discounts?

Paying discount points to get a lower interest rate can be a great strategy. Reducing the rate by even as little as 25 basis points (0.25%) can save you tens of thousands over the life of the loan.

But there is a catch. You must keep the mortgage long enough for the monthly savings to offset the purchase price of the points.

Fortunately, the math is simple; You can find out if they’re worth it in just a few minutes. At today’s low prices, there are great deals with or without discounts.

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How do mortgage points work?

Discount points, or “mortgage points,” allow you to pay extra up front to lower your mortgage interest rate. Each point usually costs 1 percent of the loan amount and reduces the rate by about 0.25%.

For example:

  • Loan amount: USD 250,000.
  • Initial interest rate: 3.50%
  • Cost per discount point: $ 2,500 at close.
  • New interest rate *: 3.25%

* Interest rates are for example only. Your own mortgage rate will be different.

Discount points on mortgages are equivalent to prepaid interest. Instead of paying this interest in small amounts with each monthly mortgage payment, you can pay a portion of the amount upfront to reduce the total amount owed.

“The prepayment usually lowers the mortgage rate, which in turn reduces the mortgage payment,” explains Ekaterina Bardos, chairman and assistant professor of finance at the University of Fairfield.

How much does a discount point lower my rate?

Usually one pip lowers your interest rate by about a quarter of a percent. But this can vary depending on the lender and the situation.

The amount by which you can lower the interest rate will depend on:

  • Your mortgage lender
  • Your loan type
  • Your loan term
  • Your loan amount
  • The number of points you have purchased

“For example, you are borrowing $ 200,000 at a fixed interest rate of 3.0%. If you prepay $ 2,000 for one discount point, you can reduce your rate to 2.75% or 25 base points. This will reduce your payment by almost $ 27 per month, ”notes Chuck Meyer, senior vice president and director of mortgage sales at Sunrise Banks.

However, he continues, your break-even point will be 75 months to recoup the value of the point you purchased, which will take just over six years.

In other words, buying mortgage points may or may not be worth it, depending on your financial situation and timing.

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Pros and cons of discount points on mortgages

The advantages and disadvantages of buying discount points on a mortgage are pretty simple.

“The good news is that the borrower gets a lower payment and pays lower interest over time,” says Mayer. “The downsides are that they have to deposit more money into the transaction in advance from their own pocket, and if they don’t stay at home for a certain amount of time, the cost will be greater than the benefit.”

This may sound simple. But it takes a little math to apply these rules to your situation. Here’s what to consider.

Things to Consider Before Buying Discount Points

Robert Killinger, senior loan officer for internal sales at Mortgage Network, says there are several variables to consider when deciding whether to pay rebate points.

  1. “First, you need to figure out how low the corresponding interest rate can fall after the points have been applied.
  2. “Second, you want to know how much credit will increase the cost of closing your loan over your available budget.
  3. “Third, determine if the added value of discount points makes sense in the long run — how long it takes to recoup the value of the points versus the overall interest savings,” he suggests.

If you don’t have enough cash for your down payment, you have little money in your reserves and you are buying a starter home that you will likely sell within a few years, buying discount items is probably not the best idea.

Benefits of Paying Discount Points

For some, however, discounts make a lot of sense.

“If you have money to spare and plan to stay in the house for at least 10 years, you might be a good candidate. [to purchase discount points], says Meyer.

Another good prospect is that the landlord is buying an investment property that he will hold for an extended period and rent it out to potential tenants.

“In this scenario, you can use discount points to lower your long-term interest rate. Your cheaper mortgage payment can lead to better cash flow in collecting monthly rent for your property, ”explains Killinger.

On the other hand, if you are looking to get rid of an investment property relatively quickly, you most likely will not recoup the value of the points paid.

Meyer also notes that buying discount points can reduce the amount of non-taxable interest that you can qualify for. “If a borrower transfers and deducts interest on their taxes, they will have more interest to write off if they keep a slightly higher rate and don’t buy points,” he says.

But not every homeowner lists their taxes, and you should discuss your situation with a tax professional.

Check Rates With and Without Discounts (26 July 2021)

When discount points are worth it

Katherine Alves, executive vice president of Homeowners First Mortgage, says you want a financial benefit from buying discount items.

“To do this, you need to calculate the cost versus the savings over a given period of time. It does this by comparing the no-score rates on the loan with the scores and analyzing the total annual savings in the monthly payment, ”Alves recommends.

“Then you need to decide if you’re going to stay in your home or on your current mortgage long enough to recoup the value of your discount points,” she explains. This is known as the “breakeven point”.

Take a look at an example.

Suppose a borrower named Steve buys a house and takes out a 30-year $ 400,000 mortgage. He offered a fixed interest rate of 3.25%.

  • If Steve had bought one discount – a $ 4,000 prepayment – he would have saved about $ 108 on each monthly payment.
  • It will take Steve 37 months (just over 3 years) to break even and recover the $ 4,000 he paid up front.

“If Steve had held the loan for the entire 30-year term, he would have saved about $ 35,000 in interest by buying a single discount point,” says Killinger.

This assumes that Steve will stay in his home and will not refinance or sell until more than three years have passed. In this case, paying for the discount will be worth it.

When discount points aren’t worth it

Now let’s look at the same scenario as above. But imagine Steve decides to sell this home two years after buying the discount point for $ 4,000.

“After 24 months of using this loan, Steve would be able to recoup less than $ 2,600 out of his initial $ 4,000 investment. With such short-term plans for his property, Steve is better off not increasing the value of his loan through discount points and better suited to get a higher initial interest rate, ”says Killinger.

Bardos reminds us that one of the most important considerations when choosing a credit score loan is the length of time you plan to stay home before refinancing or selling.

“The longer the horizon, the more profitable the prepayment of interest through points,” says Bardos.

Also keep in mind that the money needed to earn points is often better spent paying off high-interest credit card or student loan debt, setting up a reserve fund, or investing in stocks, bonds, or other investment vehicles that can generate higher returns. rate of return.

“This is especially true in our current low interest rate environment, where even pip-free rates are at historically low levels,” says Bardos.

Bottom line: is buying mortgage points a good idea?

Thus, whether or not you should buy discount points at a lower rate depends on:

  • How long do you plan to keep your mortgage
  • How many upfront payments can you afford to get discounts on closing a deal?
  • How much will your interest rate decrease when buying points

“Using discount points can be a great implementation strategy when it comes to mortgage finance. However, some analysis needs to be done to confirm whether the savings generated from the interest rate cut outweigh the value of the discount points and how this will affect your long-term plans for the property in question, ”warns Killinger.

One final note: keep the discount points in mind when comparing mortgage offerings.

Some lenders list rates with points, and some without them. And if you are comparing rates with different point structures, it is an unfair comparison of which lender is really the cheapest.

Therefore, make sure that all of your loan grades contain the same score before choosing a home loan.

Your loan officer can help you compare loan options with and without discount points to determine if the additional cost is worth it.

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