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Video — Discount Points Made Simple

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"Do you want to pay points?" is the kind of mortgage question that leaves many people thinking "I dont even know what that is!" Heres a simple explanation.

Points are pre-paid interest. You pay interest now (which is frequently tax-deductible) to lower your long-term rate. "One point" is 1% of the total loan amount.

If your lender is willing, ask to compare a loan package with 0 points to options with 1, 2 or more so you can see the short-term and long-term effect.

As an example and general guideline, on a 30-year mortgage, your interest rate will go down by about 1/8 (0.125) for each point paid -- 3% interest would drop to 2.75% with 2 points paid.

If you plan to stay in the home for a while, points can reduce your monthly payment, while the up-front tax deduction might help with first-year finances.

PRO TIP: In some market conditions, negotiating to have the seller pay points may be an option. Talk with your real estate professional and lender.

Should You Invest In Discount Points on Your Mortgage?

What exactly are these mortgage points?

Mortgage points are payments that borrowers pay to a lender in exchange for a reduction in the overall interest rate on their mortgage. It is common practice to refer to the act of paying for discount points as "buying down the rate," although the borrower is under no obligation to do so.

Be wary while looking at the stated mortgage rates online while you do your search for the financial institution that provides the greatest offer. If you read the small print, you might discover that one, two, or even three or more discount points have been reflected into the rates. This could be the case if you find that there is fine print.

The use of discount points is completely voluntary. You need to find out what a lender's rate is without having to pay a ton of money up front for the privilege.

How much of a discount does one point offer on the interest rate?

The charge for purchasing one discount point is equal to one percent of the total amount of the mortgage. As a direct consequence of this, the lending institution reduces the interest rate by 0.25% in most cases.

However, the rate can be lowered by one point by more or less than that. There is no predetermined value that specifies how much of a rate reduction can be achieved by accumulating discount points. Since mortgage interest rates change on a daily basis, it is in your best interest to look around for the best deal possible. The impact of a discount point differs according to the lender, the type of loan, and the rates that are now in force.

The term "buying points" does not always indicate making a payment equal to exactly one percent of the total loan amount. You might, for instance, be able to pay a half point, which is equal to 0.5% of the whole loan amount. In most cases, this results in a decrease of 0.125% in the applicable interest rate. You could also be offered the choice of paying one and a half points or two points to receive a further reduction in the interest rate.

What exactly is the function of mortgage points?

The interest rate and, thus, the monthly payments can be decreased by paying discount points. The interest rate, the amount borrowed, and the period of the loan (for example, whether it is a 30-year loan or a 15-year loan) are the factors that determine how much money you will save each month.

If you are in a position to pay for them, the decision of whether or not to do so depends on how long you want to keep the mortgage after the "break-even point."

The concept of the point at which one is profitable again is straightforward: You've reached the break-even point when the total amount of monthly savings equals the cost of the initial investment. After that, you will be in a better position. However, if you sell the property or refinance the mortgage before reaching break-even, you will incur a loss on the amount of money you spent for the discount points.

The point at which you are profitable again can change based on the size of the loan, the interest rate, and the period. In most cases, it takes longer than simply a few years. When you have an estimate of how long you will live in the house, you can determine when you will have made a profit on the investment.

How to determine if discount points are a good choice

When you are purchasing a home that you intend to keep for a number of years or an investment property that you intend to maintain for the long term, it may make sense to pay discount points because you will save money after you have broken even.

An illustration of how long it might take to realize a profit from the purchase of a point is provided here for your reference. Say you're taking out a $400,000 loan. Assume that you have the financial means to cover the additional expense of one discount point in addition to the other charges associated with closing.

If you bought a point, you might reduce your monthly payment on that $400,000 mortgage by approximately $57. You may calculate the number of months it would take you to make up the difference in the cost of buying the point by dividing the total cost of the point, which is $4,000, by the monthly cost, which is $57. In this particular illustration, it has been close to seventy months, or about six years.

That means that if you expected to stay in the home for six years, you would be able to recoup your initial investment, and if you were there for any longer than that, you would be able to save money. But if you left before that time, you would have been out the money you spent on buying points.

When getting a mortgage, is it possible to negotiate the points?

Yes, you can. Even if you didn't specifically request to buy discount points, some lenders may add them to your loan offer as a way to make their interest rate appear to be more competitive. In point of fact, it is a smart idea to seek for a loan offer with zero points whenever you are shopping around for other lenders. In this manner, you will be able to fairly compare the services of several lenders.

After you have selected the mortgage lender you will be working with, you are free to make a decision regarding whether or not to purchase discount points.

After the mortgage has closed, is it possible to purchase discount points?

The conditions of your loan will not be determined until after the closing has taken place. As soon as you put your signature on that mountain of documentation, the transaction will be finalized.

Is it possible for the seller to reimburse your discount points?

Yes. It is not uncommon for sellers to offer to pay the discount points that buyers require in a market that is favorable to buyers. In this scenario, you won't start off losing money, and there is no need to determine when you'll reach the point where you'll be profitable again.

Are mortgage points tax deductible?

You may be eligible to deduct the points you paid on a mortgage for your principal residence if you itemize your tax deductions rather than taking the standard deduction. This deduction is only available to taxpayers who itemize their deductions. The amount that you borrow to purchase the home could put a cap on the deduction you're eligible for.

Adan Harris
January 27, 2023
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