Mortgage discount points can be a confusing concept for many home buyers, but understanding them can save you money. Discount points are a type of prepaid interest that you pay upfront to lower your mortgage rate. Each point is equal to 1 percent of the loan amount and is paid at closing. Think of it as a way to buy your rate down – or get a lower rate than what the lender is offering.
In general, the more points you pay, the lower your interest rate will be. The amount of discount points that you’ll need to pay depends on several factors such as current market conditions, loan amount, and loan type. For example, if current mortgage rates are 4%, paying one point on a $200,000 loan will get you an interest rate of 3.75%.
It’s important to understand that discount points are not always worth it. Paying points doesn’t make sense if you don’t plan on staying in the home long enough to recoup the cost of the points through lower monthly payments or if there are other financial priorities that need to be addressed first. To determine whether paying points makes sense for your situation or not, you should compare the cost of paying points with what you would save in interest over time.
For example:
You have a $200,000 mortgage at 4% interest with no discount points paid upfront. Your monthly payment would be $954 per month for 30 years and total interest paid over 30 years would be $140,511.
If instead you paid one point ($2,000) up front at closing and got an interest rate of 3.75%, your monthly payment would decrease by about $36 per month which translates into savings of $12,960 over 30 years (total interest paid over 30 years would be $127,551). In this case it makes sense to pay one point since it will save you money in the long run.
Another factor to consider when deciding whether or not to pay discount points is how much cash you have available at closing and whether or not it makes more financial sense to use that cash towards other home buying costs such as closing costs or home improvements instead of paying points upfront.
It’s also important to note that some lenders offer programs where they will cover all or part of your discount point costs – so this could also affect your decision making when considering whether or not to pay them upfront.
In summary, understanding mortgage discount points can help save money in the long run by getting a lower interest rate on your loan; however, it’s important to consider all factors before deciding whether or not they make sense for your situation and budget. Compare total cost with total savings before making any decisions and remember that lenders may offer programs that cover all or part of your discount point costs so make sure to ask about those as well!