If you’re buying a new home or refinancing your current mortgage, it’s not surprising that you want to get the best rate possible on your loan. With mortgage rates starting to rise again, industry professionals may advise you to consider purchasing discount points.
Although discount points aren’t the answer to every financing problem, they can save you thousands of dollars on a mortgage.
Discount Points
Your mortgage lender will charge you discount points (often known as mortgage points) if they cut your interest rate. In other words, you’re paying more upfront to save money later.
Discount points are better understood as “discount percentages,” even though the name refers to “points.” The Consumer Financial Protection Bureau notes that:
- One point equals 1% of the amount of your debt.
- One point is $2,000, two points equals $4,000, etc.
In most cases, acquiring a point will lower your interest rate by around 0.25%. So if your $400,000 loan is authorized at 5%, paying $4,000 beforehand might drop your interest rate to 4.50%. If you choose, you can buy fractions of points from most lenders.
Because this option affects your overall mortgage rate, the buyer must pay the mortgage points on top of the closing costs, which is a crucial distinction.
When Is the Best Time to Buy Points?
Even though discount points are not available to everyone, they can be a terrific option for some consumers depending on their future intentions.
A long-term buyer could considerably profit from acquiring points because they will remain in the loan long enough to recoup the price of those points and save money over the life of their loan. The same holds for those who want to refinance their mortgages. You won’t want to refinance again if interest rates rise.
In addition to the higher interest rate, other charges are connected with refinancing. You may want to explore purchasing points if you know you’ll be keeping your refinanced loan for a long time and no longer have to pay primary mortgage insurance.
Should I Avoid Buying Points in Certain Circumstances?
Buying discount points to get a cheaper interest rate may sound like a good idea, but it’s not for everyone. Discount points may not “pay off” for years, depending on your specific loan and circumstances. Points paid on the first loan would be wasted if mortgage rates drop and you choose to refinance.
Short-term homeownership doesn’t justify the purchase of discount points because you will only be paying on the loan for a short period. The money could be put toward a larger down payment instead.
What You Need To Know
Lenders may require private mortgage insurance (PMI) if the down payment is less than 20% of the purchase price.
Depending on the lender, PMI costs can range from 0.5-1.5% of the original loan amount. An annual increment of 1,000-$3,000 on a $200,000 loan will increase the loan-to-value ratio to 80%.
Increase your down payment instead of paying points to get closer to the 80% loan-to-value ratio needed to remove PMI in this situation. Increase your down payment from 5% to 10% on that $200,000 loan, and you’ll save nearly two years’ worth of PMI payments and reduce your principle. In other words, your money will go directly to your loan instead of the bank, saving you even more.
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