Everyone wants the lowest interest rate possible for their loan, but sometimes the rate offered isn’t what you wanted. This is when discount points (sometimes called mortgage points) come into play. Many borrowers don’t understand what they are, how they work, and when/if they’re worth it. While buying your rate down sounds great, it’s important to understand the big picture.
What Are They and How Do They Work?
Discount points are a fee added to your closing costs to buy down your interest rate. They’re optional (lenders don’t require them), but if you want to get a lower interest rate, you may want to consider them. With discount points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time.
The amount a discount point lowers an interest rate varies by lender, but in general, one point equals one percent of the total loan amount. Lenders charge discount points in various increments and you don’t always have to pay for a full point (e.g., you may be able to lower your rate enough with 0.5 points or 0.75 points). It depends on your qualifying factors, the market rates, and how much you want to lower your rate.
Feasibility and Your Monthly Payment
When you pay discount points, you lower your interest rate which in turn, lowers your monthly payment. But, it’s important to know by how much and to keep in mind how long you want to live in your home
If paying discount points costs you $2,000 and lowers your interest rate by $20/month, it would take you 100 months (or eight years) to break even.
But, if buying the interest rate down saved you $75 a month, and the points cost $2,000, you would break even in 26 months or a little over 2 years
Can you negotiate discount points?
Yes; most lenders will negotiate with you. That said, it’s easier to negotiate when you have good credit and other strong qualifying factors.
Are discount points tax deductible?
It’s always best to consult with your tax advisor, but since they’re prepaid interest, if you itemize your deductions, you may be able to deduct the cost of the discount points.
Who are discount points paid to?
The money from discount points is paid to the lender.
Discount points can be a great way to get the lowest interest rate and if you’ll be in the home past the break-even point, it can make sense. Check out this Discount Points calculator to see if they make sense for your situation.