As you navigate through the process of buying a home and applying for a mortgage, you may have the opportunity to buy mortgage discount points. To understand if this is the right decision for you, let’s talk about what discount points are, how they work, and if they’re worth the cost.
What are discount points on a mortgage?
Mortgage discount points allow you to lower the interest rate of your mortgage when you pay a fee. Discount points are sometimes called “buying down the rate” and are completely optional.
How much does 1 discount point lower your interest rate?
For each point paid on a 30-year mortgage, the interest rate is reduced by 1/8 (or .125%) of a percentage point.
How do you calculate discount points?
Discount points are essentially prepaid interest, with each point equaling 1% of the total loan amount.
Let’s say your loan is for $300,000. If you want to reduce your interest rate, you’d pay $3,000 for 1 discount point, $6,000 for 2 points, and so on.
But it doesn’t have to always be round numbers for discount points. You can pay 1.275 points or 0.5 points. What would that look like? Let’s go back to the example of a $300,000 loan. For 1.275 points, you’d pay $3,825, and for 0.5 points, you’d pay $1,500.
What are discount points on a refinance?
Discount points on a mortgage refinance are the same as discount points on a new mortgage. The only difference is how much you pay for the discount points since points are calculated based on the loan amount.
So whether you’re refinancing to access home equity or trying to lower your monthly payment, as long as your refinance is lower than your original mortgage, you’ll pay less per point.
Who sets discount points?
Discount points are set by the lender, the type of loan, and the overall market factors (like the prime rate). Depending on these factors, sometimes you’ll receive a large reduction for each point, and other times, the reduction for each point is smaller.
But it’s important to remember that every lender has its own pricing structure, and because of this, it’s important to shop around for your home mortgage. The cost of a mortgage with one lender charging 1 discount point may not be any lower than a different lender with zero points.
How many discount points can you buy?
There are no set limits on how many points you can buy, but most lenders cap it at 4 points. This mostly has to do with federal and state limits on how much you can pay on closing costs.
Are discount points tax deductible?
Points are tax deductible when you purchase a home. But this only applies if you itemize your deductions.
Are mortgage discount points worth it?
That all depends. If you’re planning on staying in your home for some time, then it may make sense to pay for discount points to lower your overall monthly loan payment. But you’ll want to do some math to figure out how much time you need to be in your home to hit the break-even point.
For example, you pay $3,000 for 1 discount point and end up saving $50 a month per mortgage payment. To “break even,” you’d have to make 60 payments – meaning you’d have to plan to be in your home for at least 5 years.
Whether or not you decide to use discount points, be sure to request that each lender provide you with an interest rate with zero points so that you can make a decision as to what is best for you. Often the rates advertised have already been adjusted with 1 or 2 points.
Have more questions? Our team is happy to direct you to the right resources!
Your Team at Liberty Title Company of America