Anyone who has spent a Friday afternoon in a lengthy, meandering meeting understands the value of getting to the point. However, there’s a scenario where it’s even easier to appreciate the value of getting points: securing a mortgage with discount points. What are discount points on a mortgage? And why should prospective homebuyers ask their mortgage lender about them?
What Are Discount Points on a Mortgage?
Every savvy shopper loves a good discount, but most know to watch out for the fine print. Discount points offer homebuyers a chance to snag a lower interest rate, but it’s a chance that comes at a price. Learning how discount points work, discovering how they compare to other mortgage points, and exploring the factors involved can prepare you to make smart decisions about your home loan.
How Do Discount Points Work?
What are discount points on a mortgage? As NerdWallet explains, discount points are optional fees that borrowers can pay lenders to lower their interest rate. They’re essentially prepaid interest and must be paid upfront at closing. In fact, purchasing points is sometimes referred to as “buying down the rate.” A lower rate means that you’ll pay less interest, so you’ll enjoy a smaller monthly payment and ultimately pay less for your loan. While there’s no hard and fast formula, borrowers should typically expect to pay around one percent of their mortgage amount for each discount point. In turn, a point will generally reduce their interest rate by 0.25 percent. However, the exact results may vary depending on the lender, the type of loan, and the current interest rates. It’s also worth noting that the math doesn’t always work out that cleanly. Borrowers sometimes have the option to buy fractions of a point. However, everything must be sorted out before closing.
Discount Points vs. Origination Points
When people talk about mortgage points, discount points aren’t necessarily the only topic of conversation. Origination points may also be part of the discussion. What’s the difference? As Forbes indicates, discount points are optional fees used to negotiate a better interest rate, and they’re due at closing. In contrast, origination points are mandatory fees charged by the lender for processing the loan. They may be due at closing or rolled into the loan.
How Do You Decide Whether to Buy Discount Points?
Should you buy discount points? How do you decide if they’re worth the price? Some buyers forgo discount points and choose to make a larger down payment in order to focus on building their home equity faster. Others decide to pass on points because they plan to refinance in the future. However, there are costs involved in refinancing. That means locking in a great interest rate could not only save you money now but also provide additional savings in the future by eliminating the temptation to refinance. As Smart Asset points out, there are several situations in which putting extra cash toward buying down your interest rate can be a smart strategy:
- You want the flexibility of lower monthly mortgage payments or need to make them more affordable.
- You want the tax deduction. While it depends on how you file, discount points are a form of mortgage interest, so they’re often deductible at tax time.
- You plan to stay in the home for a long period and will be likely to recoup the cost of the points.
- Your credit score keeps you from qualifying for the best interest rates.
How big of an impact could discount points have on your monthly mortgage payment? Use PrimeLending’s handy Impact of Discount Points Calculator to find out. Simply plug in the loan amount, interest rate without points, loan term, number of points, and interest rate with points. Then, hit calculate. In a flash, you’ll see estimates of how much you can expect to pay for the discount points and how long it would take you to break even. You’ll also see estimates of your monthly payment with and without points. To learn more or get started on your home loan, reach out to PrimeLending Dallas today.