When you obtain a mortgage, the interest rate that you are given will have a significant impact on how much the loan will cost you. Obviously, the lower the rate, the more affordable your mortgage will be. In this case, a larger proportion of your payment will go towards the principal portion compared to a mortgage with a higher interest rate.
One of the best ways to secure a lower interest rate is to apply for a mortgage with an excellent credit rating. The higher your score, the better the odds of a lender extending a lower interest rate. Of course, the rate you end up with will also depend on what the current posted rate is.
However, you may also consider buying discount points to help lower your interest rate on your mortgage. In exchange for these points, you will have to pay certain pay lender fees. It should be noted that while buying points can sometimes lower mortgage interest rates, other times this purchase can cost more than it saves.
That’s because these points increase your closing costs despite lowering your interest rate. Whatever the amount these discount points cost you will be payable up front at closing. It’s important to crunch the numbers before you consider this purchase in order to ensure it makes financial sense.
How Can Discount Points Save You Money?
One mortgage point usually costs 1% of the loan amount. For instance, one point on a $300,000 mortgage would cost $3,000. Depending on the lender, one point can typically lower your interest rate anywhere between 0.125% to 0.25%. The lender gets the money in interest in a lump sum at closing instead of collecting it as the monthly mortgage payments are made.
If your 30-year fixed-rate mortgage of $300,000 comes with an interest rate of 4%, then your monthly mortgage payments would be $1,432. If you bought one point for $3,000, your interest rate would be reduced to 3.75% (assuming one point lowers the rate by 0.25%). In this case, your monthly mortgage payments would be lowered to $1,389. for a savings of $43 per month.
Of course, you need to account for that $3,000 that you had to pay up front to realize these monthly savings. In order to recoup that $3,000, it would take almost 70 months, or nearly 6 years to break even. After that, it’s all money in your pocket.
Discount points can also be tax-deductible in the year that you purchase your home because they’re considered a type of interest. Just make sure that you talk to your accountant or bookkeeper to make sure you’re eligible for these deductions.
Does Buying Discount Points Make Sense For You?
Purchasing discount points might be a great option if you plan on living in your home for the long haul. As illustrated above, you would realize savings after nearly 6 years have passed. If you plan on sticking around for 20+ years, you could be saving quite a bit of money. Consider how long you think you’ll be staying put.
Generally speaking, if you decide to buy discount points, you’ll want to live in your home for longer in order to get back all the money you spent buying the points. If you sell over the short-term, not only will you risk not being able to break even, you can even lose money.
Using the above example, if you sold your home after 3 years, you would actually lose money. That’s because it would take almost 6 years to make that $3,000 back. If you sell before that time, that’s as good as money lost.
Another consideration to make is the size of the down payment you’re able to come up with at closing. If you’re already scrambling to come up with the upfront costs associated with closing, it might not be worth it for you to be strapped for cash in order to gather up an extra $3,000 at closing.
The Bottom Line
In general, you’ll be able to save more money if your mortgage amount is bigger, the interest rate is higher, and the mortgage length is longer. If the current posted interest rate is already rather low and your mortgage is only short-term, you might not realize much savings at all. Carefully consider your current situation and where you see yourself in the future, and speak with your mortgage specialist to determine whether or not buying discount points is worth it for you.