Buying a home is one of the most significant decisions you will make in your…
If your mind is set on a specific interest rate, but the market isn’t cooperating, you might consider paying mortgage discount points.
At the right time, discount points can help you reduce your interest rate, but they cost money upfront. They can be an excellent way for some people to make their mortgage payments more affordable, but they aren’t suitable for everyone.
Here’s everything you should know about discount points and how they work.
Mortgage Discount Points Defined
Mortgage discount points are like prepaid interest. You pay the interest upfront (at the closing) in exchange for a lower mortgage rate. Lenders can then afford to give you a lower mortgage rate, which is the rate you pay for the life of the loan.
Discount points increase your closing costs but may save you money throughout the loan’s term by providing a lower mortgage payment.
How Does Mortgage Discount Point Work?
As we said above, discount points lower your mortgage rate, but you must pay the amount upfront. Lenders charge discount points as a percentage of your loan amount. For example, a 1% discount point means 1% of your loan amount. So, if you borrowed $200,000, you’d pay $2,000 for one point and $4,000 for two points.
How much one discount point lowers your mortgage rate varies by lender, but on average, one point reduces the rate by aprox. 0.5%.
So, for example, you may pay several points and lower your rate even further, but it’s not always worth it.
Who Should Pay Discount Points?
The easiest way to tell if you should pay discount points is to determine if you can afford it. Your closing costs will likely be 3% – 5% of the loan amount without discount points, so first, decide whether you can afford it.
If you can, then determine your plans for the house. Ask yourself if this is a short or long-term purchase, and how long do you plan on staying in the current loan.
If you only see yourself living in the house for a few years, paying discount points won’t make sense. You won’t save enough money while in the home to justify paying the higher closing costs.
But, if you think this is your ‘forever home,’ or you’ll at least be there for a while and plan on staying in the current loan for a while due to low rates, buying the rate down may make sense.
However, if you’re on a tight budget, unsure of your plans, or don’t mind the slightly higher monthly payment, you may want to skip the discount points.
How to Tell if Discount Points Are Worth It
Even if you decide you can afford the discount points and want to take advantage, it may not make sense.
You should first determine if they are worth it. To determine this, you should calculate your break-even point.
Understanding your Break-Even Point
Your break-even point is where you pay off the discount points with the savings from the lower rate.
For example, if you pay $4,000 in discount points and it lowers your mortgage payment by $100, it will take you 40 months to pay off the $4,000 you paid upfront for the discount points.
If you aren’t sure how much longer than 40 months you’d be in the home or the mortgage, paying for the points won’t make sense. However, if you plan to be in both for the next 10 – 20 years, you’d save a significant amount after paying off the discount points.
Are Discount Points Negotiable?
Some lenders will negotiate with you on many terms, including your discount points. When you shop for the best rate, ask lenders for a quote with zero points and quotes with points.
You can then compare your options and negotiate with the lender, especially if you have offers from other lenders.
Pros and Cons of Mortgage Discount Points
Like any mortgage decision, there are pros and cons of discount points. Here’s what to consider.
You’ll lower your interest rate – A lower rate is the most significant benefit of discount points. If you are in the home for the long term, a lower rate can save you thousands of dollars over the loan’s term.
Easier to qualify for a larger loan – A lower monthly payment means you may have a lower debt-to-income ratio, which is a large part of the qualifying process. If your DTI is close to the limit, buying the rate down may allow you to qualify for a larger loan.
Save thousands over the life of the loan – Buying the rate down allows you to save thousands of dollars on interest. But, of course, the less money you pay in interest, the more you save.
You need more capital upfront – You must have more money available at the closing to buy the rate down. You’ll pay the fee with your other closing costs, which can significantly increase how much you must bring to the closing table.
You could lose money – If you change your mind and sell the house early or want to refinance, you could lose money because you’re paying the loan off early and didn’t reap the full benefit.
It could make it harder to make a down payment – Investing money directly in the home earns you instant equity and can make you a profit when you sell. However, if you buy the rate down instead, you may have less money to invest in the house.
Mortgage discount points may help you get a lower payment and save thousands of dollars over the life of the loan, but they aren’t for everyone.
First, you must ensure you can afford the payments and everything else required when you buy a home, including the down payment and closing costs. Next, given your plans, you must ensure it makes sense to pay them.
If mortgage points make sense, there are many ways to ensure you get the rate you can afford and that’s where we at Innovative Mortgage Brokers come in. We can help you determine if paying discount points is a good idea based on your specific financial situation and goals. Here’s how:
- Assess your financial situation: At Innovative Mortgage Brokers we will look at your income, expenses, credit score, and other factors to determine if paying discount points will benefit you in the long run. We will consider your monthly budget and how much you can afford to pay upfront.
- Evaluate loan options: We can help you evaluate different loan options, including those that offer discount points. At Innovative Mortgage Brokers, we help you compare interest rates with and without discount points to determine which option will save you the most money over the life of the loan.
- Provide expert guidance: We provide expert guidance on whether paying discount points is the right choice for you. We explain the pros and cons of paying discount points and help you make an informed decision.
If you’re in the market for a mortgage in Pennsylvania or Florida, we would love the opportunity to earn your business! Overall, we are committed to making your mortgage experience as seamless and stress-free as possible with extremely competitive rates and fees. Contact us today to learn more about our services and how we can help you achieve your homeownership goals in Pennsylvania or Florida.