The mortgage discount points are a part of a borrower’s mortgage interest which they choose to pay upfront. When this part of the interest is paid upfront, the borrower can enjoy a low-interest rate for the term of the loan. Hence, if you intend to stay in your home for a period of 10 to 15 years, mortgage discount points make a lot of sense.
What are mortgage points?
It is important to understand what mortgage points are and how they work. The points are a percentage of the loan amount. This means one point is equal to one percent of the loan amount. It is an additional upfront cost when you close the loan. However, it is also a way for borrowers to negotiate a low rate of interest on the mortgage. If you choose to pay upfront 1% of the total interest applicable over the tenure of the loan, you can unlock a mortgage rate that is about 0.25% lower.
Mortgage discount points do not mean a large down payment. You simply buy points from the lender for a right to enjoy a lower interest rate for the entire tenure of the loan. It helps save money on interest.
Types of mortgage points
Let us take a look at the two basic types of mortgage points available today.
A discount point shows the prepaid interest that can help negotiate a low-interest rate for the tenure of the loan. It is an upfront payment. For example, if your home loan is quoted at 4% mortgage rate for an amount of $500,000, you may buy one discount point at $5,000 to get an interest rate of 3.75%.
So — for example — if your $300,000 home loan is quoted at a 4% mortgage rate, you might buy one discount point at $3,000 to get a 3.75% interest rate instead.
The origination points are lender fees that are charged at the time of closing a loan. It will not save money on interest but can sometimes be rolled in the balance of a loan and can be paid off over time. It is not an upfront payment.
For example, if you borrow $200,000 and the bank is charging 1.5 origination points, you will pay $3,000 in origination points. In most cases, the fees charged by the bank to create a loan is 1% of the loan amount.
How do discount points work?
You will receive an offer from the lender after you apply for a loan. There will be multiple rates and a base rate. It will also have lower rates you can get if you purchase discount points. The discount points represent interest that you have to pay on the loan. If you want to purchase the points, you need to pay a percentage of the loan amount at closing and enjoy a low interest for the entire term. With every point, you can lower the interest rate by 0.25%.
Mortgage points are tax-deductible like the normal mortgage interest you pay. They are used only for fixed-rate loans. However, they are available for adjustable rate mortgages but at the time of purchase, they will only lower your rate for the intro period and not the entire term.
Are the points worth it?
If you buy discount points, you will reduce the monthly payment but you will increase the upfront cost of the loan. It can take about 5 to 10 years to recoup the upfront cost of the points. If you do not want to buy the points, you can choose to make larger down payments to build equity in the home and pay off your mortgage early. It is another alternative to save money on interest payments.
Mortgage discount points are worthwhile when:
- Your credit score does not qualify you for the lowest rate,
- You require a low monthly interest cost to make the mortgage affordable,
- There is excess money to put down,
- You want an upfront deduction from tax,
- The intention is to keep the home for a long time.
How to negotiate mortgage points
You can negotiate discount points and origination points when you apply for a loan. You can speak to your loan officer after you have been approved for a loan. If you want to successfully negotiate the points, the best thing to do is apply for mortgages with multiple lenders. When you get offers, you can let every lender work to earn the business while you enjoy low costs. It will not hurt your credit because a credit bureau will treat multiple credit checks from lenders within 30 days as one credit check.
Impact of mortgage points on closing costs
Discount points and origination points will increase the upfront cost of getting a mortgage. They will not increase the equity in the property you are borrowing against. Discount points are optional and if you want to stay in the house for a decade or more, they may be worthwhile.
There is no restriction on the number of mortgage points you can buy. But you will rarely find a lender who will allow you to buy more than four mortgage points. This is because of the restriction by the Federal and State on the amount you can pay in closing cost on a mortgage.
Before you decide on buying mortgage discount points, it is best to calculate how long it will take for you to recoup the upfront cost of purchasing points. It is the number of months it will take for the monthly payment savings to be equal to the upfront cost of buying points.
Make an upfront payment only if you find it worthwhile and if you are having trouble getting a low-interest rate due to your credit score.