Mortgage discount points are parts of a borrower’s mortgage interest paid in advance. Borrowers can lower their mortgage loan interest rate for the term of their loan by paying points upfront. Purchasing mortgage points may be worthwhile if you intend to stay for at least 10 to 15 years in the purchase home.
What Are Mortgage Points?
Mortgage points get calculated as a percentage of the loan amount (1 point equals 1% of the loan amount). They are an additional upfront cost when you close your loan, but they also allow borrowers to negotiate a lower interest rate. Borrowers can unlock mortgage rates that are about 0.25% lower by paying 1% of the total interest to be charged over the life of a loan upfront.
It is worth knowing that points do not equal a larger down payment. In lieu, borrowers purchase mortgage points from a lender in exchange for the right to a lower interest rate for the tenure of their loan. Purchasing points does not help you build equity in a property; it simply saves you money on interest.
Discount Points Vs. Origination Points
Mortgage points are of two types: origination points and discount points. Prepaid interest in the form of discount points can get used to negotiate a lower mortgage loan interest rate for the term of a loan.
On the other hand, origination points are lender fees charged at the time of loan closing. Although origination points can sometimes be rolled into the balance of a loan and paid off over time, they do not save borrowers money on interest. Discount points, on the other hand, must be paid in advance.
What Are Discount Points?
When you opt for home loan apply online and get approved for a loan, your lender will make you a loan offer. The lender will offer you multiple rates, including a base rate and lower rates if you purchase discount points.
Those discount points represent the interest you pay on your loan. If you choose to buy points, you pay a percentage of your loan amount at closing in exchange for a lower interest rate for the loan term. Typically for every mortgage point you purchase; your mortgage loan interest rate is reduced by 0.25%.
Mortgage points, like regular mortgage interest paid over the life of your loan, are typically tax-deductible. Mortgage points, on the other hand, are generally reserved for fixed-rate loans. They are available for adjustable-rate mortgages (ARMs). But when you purchase them, they only lower your rate for the duration of your intro period—which can be several years or longer—until the rate adjusts.
When Paying Points Is Worth It
When you buy discount points, you lower your monthly payment but raise the initial cost of your loan. Because of the difference in monthly payments, it usually takes five to ten years to recoup the initial cost of discount points.
Instead of purchasing points, many borrowers make larger down payments (or make extra mortgage payments) to build equity in their homes and pay off their mortgages sooner, which is yet another way to reduce interest payments.
Still, buying points may be worthwhile in some situations, such as when:
- Your credit score prevents you from receiving the best rates.
- You have additional money to put down and want the upfront tax benefit.
- You need to cut your monthly interest expense to make a mortgage more affordable.
- You intend to keep your home for a long time, so you may be able to recoup the cost.
Of course, this is only true for discount points. Origination points are fees paid to a lender to secure a loan. While these fees are sometimes negotiable, borrowers get forced to pay them to secure a loan.
How to Bargain Mortgage Points?
When you apply for a loan, negotiate both the discount and the origination points. But it isn’t always the case. Once you get approved for a loan, the only way to know for sure is to speak with your loan officer.
Applying for mortgages from multiple lenders is one of the best ways to negotiate, discount, or origination points. When you receive loan offers, you can let each lender compete for your business by negotiating lower interest rates or closing costs.
Mortgage Points and Closing Costs
Both discount and origination points raise the initial cost of obtaining a mortgage. However, neither of these costs increases your equity in the property against which you are borrowing.
These costs are also optional in the case of discount points. They may be worthwhile if you plan to stay in your home for at least 10 to 15 years and want to lower your monthly mortgage payment.