Should You Buy Points to Lower Your Interest Rate?
Discount points are fees paid to a lender at closing in order to lower your mortgage interest rate. Sometimes the purchase costs you more than it saves.
How Much Do Points Cost?
The cost of each point is equal to one percent of the loan amount.
Example: For a $100,000 loan, every $1,000 buys one loan discount point.
Does Buying a Point Lower Interest?
Each discount point paid on a 30-year loan typically lowers the interest rate by 0.125 percent. A 7.5 percent rate would be lowered to 7.375 percent if you purchase one point.
Paying for points lowers your interest rate by paying the lender in a lump sum at closing rather than collecting the interest as you make payments on your loan.
Should I Buy Points?
Buying points depends in part on how long you plan to keep the loan. Use a mortgage calculator to help you decide.
- Calculate the amount of your monthly payment at the interest rate you will be charged if you do not pay points.
- Calculate the amount of your monthly payment at the lower rate if you do pay points.
- Deduct the lower payment from the higher payment to find the amount saved each month.
- Divide the amount charged for points at closing by the monthly amount saved. The result is the number of months you must keep the loan to break-even on paying points.
Break Even Example
$100,000 Loan – 30 Year Term
- 7.5% Interest, no points = $699.21 monthly payment
- Buying 1 point for $1,000 = monthly payment $690.68
- Monthly Savings = $8.53
- $1000 / $8.53, = 117 months
Your break-even point is 117 months—or nearly ten years to recover the cost of buying the discount point (considering only the simple calculation of those funds at today’s value).
Do you plan to stay in the house that long? If you are not planning on living in the home for 10 years or longer, buying points might not make sense.
Slightly Lower Principal Balance
If you look at an amortization schedule and compare two loans, you’ll see that the lower interest loan does have a slightly lower principal balance at the end of 117 months, $87,024 versus $87,259 for the 7.5 percent loan. So you might want to consider that savings to help you decide whether or not to buy points.
Can the seller pay for my discount points?
Talk with your lender about what’s allowed with your loan. The seller will generally ask a higher sales price if paying a portion of your fees, but you can move into the house with less cash at closing.
Are discount points tax deductible?
Yes, points paid for residential real estate are tax deductible in the year they are paid. Buyers may deduct the amount paid even if the seller pays for the points at closing.
Are discount points the same as an origination fee?
An origination fee is a fee charged to process your loan. It typically costs the same as one point, but it is a different type of fee. Ask if you will be charged an origination fee.