When you buy a home and lock in your interest rate, you may have an option to pay points. That can help lower your interest rate. A small change in the interest rate can save you thousands over the life of the loan.
A discount point equals a percentage of the loan amount. For example, one point would equal 1% of the loan amount. However paying a point doesn’t lower your rate by a point, it may only lower it by .25 to a .50 point. Every day that amount will vary based on pricing.
Why would you pay discount points? The biggest benefit of paying points is a lower monthly mortgage payment. For example, let’s say you are approved for a $250,000 loan at a rate of 6.5%. Let’s say pricing is set where if you pay one point ($2500), the rate drops to 6.125%. (This is truly an example – rates do change daily and the amount you pay in points can also change.) Here is what that would look like:
- Without points (6.5%) – payment is $1580
- Paying one point ($2500) – payment drops to $1519
- Monthly savings is $61
- Yearly savings is $732
- 30 year savings is $21,960
The biggest question you need to ask is how long it takes to recoup the $2500 investment. In this example, it would take about 41 months ( about 3.5 years) to recoup the cost. So how long are you going to live in the home? And is there any chance you would refinance before 3.5 years is up? Those are typically unknown answers, but you should have an idea of how long you will live in the home. You want to make sure you recoup the money within a couple years – usually 2-3 years, so this option may make sense.
When you talk to your loan officer about paying points, ask for a couple options. Maybe you can lower the rate by an .125 by paying a .25 point – that may make more sense depending on how long it takes to recoup the cost. I usually break down the options and show 3-4 payments and the cost of each. Sometimes it makes sense and sometimes it doesn’t.
Remember this does affect your cash to close. If you are tight on cash for closing, it may not make sense to pay down the rate. If you have seller paid closing costs, sometimes there is extra money that can be used to pay down the rate.
For those that itemize their taxes, paying points might be a tax deduction if the loan is your primary residence and a purchase. For those refinancing, points usually are deducted over a time period. However to get the best answer for your situation, check with a qualified tax advisor.
Paying points can make sense if you are going to be in the home for a few years and you want to lower your monthly payment. It may not make sense if you only plan to keep the home for a short time or if you think you might refinance in a couple of years. The best option is to talk to your loan officer about options and payments to get a better idea of what it will cost you and the long term savings.
Leslie Vanderwerf, NMLS ID#335509, CrossCountry Mortgage LLC, An Equal Housing Lender, NMLS#3029 – Email – Website
30 year sav
