When taking out a mortgage, you can actually get a “discount” on interest rates for the life of the loan by purchasing discount points. In order to avail of reduced interest fees, you have to buy these points upfront. So, it is actually a one-time closing cost that you will have to pay the lender.
Each point you purchase will cost 1% of your loan and can lower your mortgage rate generally by 0.25% or 25 basis points.
This means if you borrow $100,000 with an interest rate of 3.5%, you will pay $1,000 for one discount point and will shoulder 3.25% interest. If you buy 2 points, then you will pay $2,000 with only 3% interest rate.
You can purchase from one up to four points, depending on the marketplace and the lender. It is also wise to take note that not all creditors follow the 0.25% basis point for every discount point ratio. So some creditors may not give you a 0.50% interest reduction even if you buy 2 discount points. Make sure to get the exact figures before closing a mortgage deal.
Questions to Ask before Buying Discount Points
1. Do you have enough cash now?
Remember that you have to pay for these points upfront. So you need to make sure you have enough cash for that additional expense, especially since you also have closing costs, reserves, and a down payment to cover.
2. How long are you planning to own your house?
The attractive feature of discount points is you get to enjoy reduced interest payments throughout your loan term. However, you will actually get to enjoy this benefit only if you plan to live in your mortgaged property long enough to get any savings from the lower interest rates.
3. Will you break even?
The easiest way to figure this out is by computing how many months it’s going to take for you to recoup how much you spent on points. This is called your break-even point. Just divide the sum you paid for the discount points by the amount you get to save each month.
Ultimately, these three questions can guide you in deciding if buying mortgage discount points is actually worthwhile.