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If you apply for a mortgage loan today, your lender might propose that you pay a discount point or two to get a better deal. But what are discount points exactly and will they really be beneficial?
One mortgage point is equal to 1% of the loan principal, so if you plan to take a loan for $300,000, a point is $3,000. Points are sort of a prepayment on a loan to avoid paying a certain amount of interest in the future. Each point shaves off approximately a quarter percent of your interest rate. Before you agree to pay a point or more to your mortgage lender, ask yourself these questions:
1. Is This THE House?
The first consideration when deciding if you should buy points is how long you plan to stay in the same house. Is this the house that you will retire in? If so, it may be worthwhile to pay points now because it could save you thousands over the course of the loan. But if you plan to stay in the house for just a few years before moving on, points could be a waste of money.
2. Will You Refinance Soon?
Some mortgage brokers get away with selling borrowers discount points, even though the likelihood of refinancing in the near future is high. If you take out a loan and then refinance two years later for an even better rate, it’s almost like moving into a new house—you lose the benefit associated with prepaying the point on the first loan.
3. Do You Have the Money?
Another more obvious question to ask yourself when deciding if you should buy a point is, “Do I have the cash to do so?” In many cases, you have to pay for discount points out of pocket at closing. Decide if you can afford to pay the extra money now or if you would rather save the cash for other needs, like buying furniture for your new house.
Run the Numbers
Now that you’ve pondered these questions, take a moment to run the numbers. Pull up an online mortgage calculator and run two hypothetical loans—one at the proposed interest rate without points and one if you do pay the points. Look at the total interest you’ll pay in both scenarios, then look at the amortization charts for both. At what month in time does paying the point benefit you? Use this information to make your final decision.
