It is an age old debate – should you or should you not pay discount points on your mortgage? There is no blanket right or wrong answer; every situation is different. The one similarity that every homeowner or soon-to-be homeowner has is the need to weigh the pros and cons as they pertain to your particular situation.
What is a Discount Point?
Let’s start with discussing what a discount point is and what it does for you. When determining the amount of “a point” on your mortgage, you simply take one percent of your loan amount. For example, on a $300,000 loan, one point equals $3,000. This amount gets factored into your closing costs and needs to be paid at that time. In essence, this fee is the equivalent of prepaid interest because in return for paying a point, the lender typically offers you a lower interest rate. The $3,000 in the previous example is then money towards the interest that would have been collected if you had taken the higher interest rate and not paid any discount points.
Calculating your Payment
Now that you know what a point is and how it is calculated, it is time to put it into real terms with your anticipated mortgage. Typically one point will lower your interest rate by ¼ percent. Knowing this information allows you to calculate your mortgage payment based on the interest rate with no discount points and then again with ½, 1 or more discount points, depending on how low you wish for your rate to be. You can then use these numbers to figure out what is right for you. If you are going to save $50 a month, compare that to how long it would take you to recoup the amount of money that you had to pay upfront in order to get that rate. If you had to pay $3,000, like our previous example, it would take you 60 months or 5 years to make that money back.
Determining the Value in your Savings
Once you know how much money you will be saving every month and how long it will take you to make back what you paid up front, you can determine if it is worth it for you. $50 savings a month can add up quickly, but if you do not plan on staying in the house for a long time, that $3,000 that you paid up front might never get recouped, making it unnecessary to pay for the lower rate. On the other hand, if you plan on staying in the house for the full term of the loan, then $50 a month can definitely add up. If you stayed in the home for the full 360 payments, you would save $18,000 over the term of the loan – making that $3,000 upfront payment well worth it.
Will you Refinance?
Another question to consider is whether or not you will refinance in the future. Understandably it is not possible to know for sure whether you will refinance, but there are some key factors that you could consider right now:
- Does the house need work that might prompt you to take out a 2nd loan or try to get a cash-out refinance in the future?
- Is the rate that you are taking now higher than you would like, even with the discount?
- Are you paying Private Mortgage Insurance?
If you answered yes to any of these factors, you might not want to pay for discount points. Refinancing within the 5 years in the above example would hinder your savings and make the purchase of discount points unnecessary. If you do not see yourself refinancing, however, especially if you are happy with the rate you are getting, it might be worth paying for that lower rate in order to save over the life of the loan.Click to See the Latest Mortgage Rates»