Defined as a form or prepaid interest, discount points, or mortgage points, allow consumers to get a lower rate on a fixed-rate mortgage. This indirectly means that mortgage points and interest rates are inversely proportional, each discount point paid lowering the rate by 0.25 percent. Discount points should not be confused with origination points, which are typically paid by borrowers to cover the cost of processing and closing home loans.
Are Discount Points Worth It?
One question many people ask before buying discount points is: Do they REALLY lower mortgage payments?
Usually, lenders offer borrowers various combinations of interest rates and mortgage points. A homeowner should consider both the rate and the total number of points when he reviews the offers from different lenders. That’s because buying mortgage points is a wise financial decision only if he plans to live in the house long enough to recoup the money spent on points. If the borrower sells the house too soon, he won’t recoup his investment.
Additionally, if the person intends to pay off his mortgage early, the charges the lender may apply for making payments that go over the agreed monthly limits will wipe out part of the savings resulted from buying discount points. Most lenders allow borrowers to overpay up to 10 percent of their mortgage amounts without penalties.
Another important point homebuyers tend to overlook is whether or not they can afford to pay for discount points. On a $150,000 mortgage, 4 points are relatively affordable ($6,000), considering that 1 discount point equals 1 percent of the mortgage amount. However, buying 4 points on a $450,000 home loan will total $18,000, which is often more than a borrower can afford.
A little math illustrates that paying less interest will allow homebuyers to qualify for a larger mortgage amount on the same income, which means that they could get a more desirable home in a good neighborhood. As well, they can build equity faster, which enables them to borrow against home equity sooner.
One more aspect people should consider before buying points is private mortgage insurance, or PMI. This type of insurance is typically required when the buyer puts down less than 20 percent of the home’s value and ranges between 0.5 and 1 percent of the loan amount per year (e.g. between $750 and $1,500 a year, on a mortgage of $150,000). If a borrower must choose between purchasing mortgage points and making a larger down payment, he should take into account the net benefit of each option before making a final decision.
Purchasing a home is a major investment. For this reason, homeowners should plan carefully, shop around, look at the numbers, decide what they can afford, and determine whether they should make a large down payment, pay for discount points, or look for a less expensive property.