Mortgage Discount Points: Are They Worth It?
Points or no points? That is the question. Mortgage discount points are a way buyers pay more upfront in exchange for a lower interest rate. Knowing if these points are a worthy investment requires a few considerations, especially if you’re borrowing a Jumbo loan. Ultimately, the best way to know for sure if points are right for you is by getting a guaranteed pre-approval.
How do Mortgage Discount Points Work?
One discount point is typically equal to 1% of the loan amount. Each point typically lowers your interest rate by 0.25%, and a lower interest rate means a lower monthly payment. However, in lowering your rate, you will increase your upfront payment. Points, therefore, call for a little bit of give and take.
For example, let’s say you get a $650,000 loan on a 30-year fixed Jumbo mortgage at a rate of 5.375% (5.485% APR)*. Your monthly payment with no mortgage discount points would be $3,639.81.
Now let’s say you purchase 1 discount point. This means you will be paying $6,500 upfront in points, but your interest rate will drop to 5.125%. Your monthly payment is now $3,539.17. This saves you $100.64 per month or $1,207.68 per year.
The Pros and Cons of Mortgage Discount Points
When you break down the numbers, you see the pros and cons of both options, but which is better? That answer depends on your personal situation.
If you foresee a change in employment, for example, to entrepreneurialism, working on commission, earning large annual bonuses in lieu of regular pay, or another position where your income may not be as predictable as it is now, it may be worth it to pay more upfront. On the other hand, if you expect your income to steadily increase over time, a higher monthly payment may be a smarter financial decision.
The other factor to consider is how long you will be staying in your home and if it is long enough to reach a break even point.
How Do I Reach the Break Even Point?
Put simply, mortgage discount points aren’t a great idea unless you will reach the break even point. The break even point is the time it takes to recover the cost of your prepaid points.
To calculate what your break even point is, divide the cost of the mortgage points by the amount the reduced rate saves each month. The result is the number of months it takes to reach the breakeven point.
So pulling from our above example, you paid $6,500 upfront for mortgage points. You are saving $100.64 each month. So you would calculate 6,500/100.64 and find that it takes about 64.5 months or a little over 5 years to recover the cost of your discount points.
Typically, it takes about 6 years for buyers to reach the breakeven point. However, depending on the number of points, it could take as much as 10-15 years. That said, refinancing could also inhibit you from recouping the money you spent on points if you do so before the breakeven point.
Bottom line, if you are going to spend only a brief period in your home or you plan to refinance in a few years, you likely would lose money by buying points.
Are Mortgage Discount Points a Good Idea When…
We know that every home purchase is different. Here are a few additional circumstances that may leave you asking if mortgage discount points are the best call.
Getting a Jumbo Loan
Paying for points on a Jumbo Loan is like paying for points on a conventional mortgage, just with higher loan amounts. Therefore, you should still consider how your income may change going forward, how long you plan to stay in your home, and if you think you will refinance soon after your purchase.
An additional factor to look at is tax rates. Mortgage points are tax deductible in the year you secure the mortgage. If you get a Jumbo mortgage in a year where your tax rate is high and you expect it to be lower in future years, you can buy mortgage discount points and lower your taxable income when your tax rate is high.
When Rates are High
Lastly, many buyers are wondering if mortgage discount points are a good option if they are buying when rates are high. Although this is logical, we also want to remind you that when rates drop, you may choose to refinance. If you do so before the breakeven point, you will not recoup what you spent on your points.
Want More Pointers on Points?
We hope to have provided you with some guidance in understanding mortgage discount points. However, we also know that there are many details to consider when making mortgage decisions. If you still have questions about what is best for your personal purchase, our mortgage bankers are ready to help.
*Points current as of 8/23/2022