You’re working on your new home loan, and you’ve been offered something called “discount points”. What are they, how do they work, and are they a good option? Find out how and when to buy discount points and the difference between different types of mortgage discount points that might be charged when you take out a home loan.
Buying a house can be the most expensive purchase of your life, and reducing the costs of your mortgage is a big part of balancing your budget. How can mortgage “points” help, and when is it a good idea to buy discount points?
What are mortgage “discount” points?
In most cases, mortgage discount points are fees you pay your mortgage lender to reduce the interest rate on the loan. If you are “buying down the rate,” each point that you buy typically costs one percent of the mortgage amount. Each point is worth around a quarter of a percent of interest for the life of your loan (the worth of the point will vary by lender.)
- You have a $200,000, 30 year fixed rate mortgage home loan.
- You have an interest rate on your mortgage of four percent.
- You buy discount points: two points at a cost of $2,000 each.
- Each point is worth a quarter of a percent off your interest rate
- At closing, you pay this $4,000 total to your lender.
- Your interest rate is lowered from four percent to three and a half percent.
You’ll be informed of your option to buy mortgage points well before closing, and if you decide to buy discount points, they will be listed on your closing disclosure, which you receive and sign at least three days before your closing date.
Benefits of Buying Discount Points
The main reason to buy discount points when buying a home is that you can save a lot in interest over the life of your loan.
Example of how mortgage points reduce interest
- Your loan principal is $200,000, and your interest rate is four percent.
- You buy two points for a total cost of $4,000, and a total value of half a percent off.
- Now you have a three and a half percent interest rate.
- Over the life of the loan, you’ll pay only $898 a month instead of $954
- At the end of your loan period you’ll have saved $20,680.
Mortgage discount points are basically prepaid interest. As such, they are tax-deductible on up to $750,000 of mortgage debt. You simply have to file itemized taxes and then list the deduction on Schedule A of Form 1040. You’ll claim it a little at a time, year after year.
Disadvantages of Discount Points
The advantages of discount points only apply if you stay in your home long enough to recoup the payout at closing. If you refinance or sell the house within a few years, the mortgage points don’t help you.
In the example above, the savings accumulate monthly to the tune of a $56 lower mortgage payment. To recoup the $4,000 you paid at closing, you’d need to stay in the house at least 71 months. If you sold or tried for a refinance in less than 70 months (almost six years) you lose your advantage.
Mortgage “origination” points
Another type of mortgage points is called “origination” points. Unlike discount points, these are charged by lenders who originate, review, and process your loan. They also usually cost one percent of the total mortgage.
If your lender charges 1.5 origination points on a $200,000 mortgage, you’d have to pay an extra $3,000 at closing. You can try to negotiate these down, or you can look for a mortgage company and lender that doesn’t charge origination points.
Origination points are not tax-deductible, since they are considered a service fee and not prepaid interest.
When You Should Buy Discount Points
If you can afford to buy discount points when buying a home, and plan to stay in the home long term, you can save a lot of money. If you’re short on your down payment, or can bump yourself over a lower interest threshold by increasing your down payment, it might be better to use your extra money that way instead.
Consider your future, how long it would take you to break even, and the advantages and disadvantages of buying discount points carefully before you make your decision. Your Sammamish loan officer can help you if you have any questions.
Why Choose Sammamish Mortgage?
At Sammamish, we believe in finding every possible advantage for our home buyers. We’ll let you know if your chosen home loan product allows you to buy discount points when buying a home, and calculate what your lender approves as the value of your points.
If you already are securing a very low loan rate, and may not stay in the house long enough to recoup your prepaid interest, we’ll make sure to let you know.
Sammamish Mortgage has been in business since 1992, and has assisted many home buyers in the Pacific Northwest. If you are looking for mortgage financing in Washington State, we can help. Sammamish Mortgage offers mortgage programs in Colorado, Idaho, Oregon and Washington.
Contact us if you have any mortgage-related questions or concerns. If you are ready to move forward, you can view rates, obtain a customized instant rate quote, or apply instantly directly from our website.