Should You Buy Discount Points for Your Mortgage?
Amongst all the confusion of mortgages, discounts points are actually very simple. You can purchase discount points and each point represents a reduction in your mortgage APR. Typically, one discount point costs 1% of your mortgage and gets you a reduction of 0.25% of the APR. For example, if your mortgage loan is for $50,000, then it will cost $500 for one point. There is usually a cap of how many discount points you can purchase.
Buyers should be aware that discount points are NOT the same as origination points. Origination points also usually cost 1% of the loan. However, they get paid to the loan officer and do not lower the interest rate. Most loan officers are willing to negotiate on origination points and some loan officers don’t require any origination points at all. By contrast, discount points are essentially pre-paid interest which compensates for the reduced interest. Discount points are tax deductible and filed as mortgage interest on the 1040, Schedule A tax form. Origination points are not tax deductible.
Whether or not to buy discount points primarily depends on how long the loan is that you are taking out. If the loan if for a long period of time, then you are more likely to benefit financially for paying for discount points.
- For example: If your mortgage loan is for $100,000 and has an interest rate of 6%, then you would be paying $599.55 monthly for principal and interest.
- If you bought 3 discount points, it would cost $3,000. The discount points would then reduce your monthly payments to $522.20 monthly, representing a monthly savings of $47.35.
- To figure out how long it takes to recoup the discount point costs, you should divide the discount point costs by the money saved ($3000/$47.35). In this case, it would take you just over 63 months (5 years) to recoup the cost of the points.
There are specific mortgage calculators for discount points. These discount point calculators will not tell you whether it is a good idea to buy the points or not. Instead, they calculate how long it will take before you recoup the price of the discount points. If it is going to take you almost the full duration of the loan to recoup the points, then it may not be worth paying for the discount points. For example, if it will take 4 years and 8 months to recoup the points but the loan is only for 5 years, then you aren’t saving much in the long run. But, if the loan is for 10 years, you could save a lot in the long run.
To calculate the long term savings, you will need to use a mortgage calculator to figure out how much your loan will actually cost you. With the above example, a $100,000 loan for 25 years at 6% would cost about $150,000 by the time you paid it all off. But, with 3 discount points, you would be paying 5.25% instead of 6%. That would make the long-term costs about $131,000. As you can see, paying $3,000 upfront means you would save nearly $18,000 over the long run.