Discount points are fees home buyers pay at closing for a lower mortgage interest rate. One point equals 1% of the loan amount. Banks typically can offer lower interest rates if the home buyer is willing to pay more upfront.
Here’s an Example
Let’s say you are shopping around for your mortgage and a loan officer quotes you 4.00% on a $200,000 with no discount points. You can ask them for a lower interest rate, but this isn’t free! They will charge you discount points to offset the lower interest rate. The loan officer might say, “I can offer you a 3.75% interest rate with a 1 point discount point.” That means you’ll have to bring an extra $2,000 ($200,000 loan amount X 1%) to the closing table.
When Should You Pay a Discount Points?
The difference in your payment in the example above is $29 a month (Principal and Interest of $955 versus $926). You should only pay the discount point if you plan on living in the house long enough to recoup the $2,000 with lower payments. In order to see how many months that is, just divide the discount point by difference in payment. In this case $2,000 / $29 = 69 months. If you plan on living in the house for less than 5 years and 9 months you should not pay the discount point.
Even if you plan on being in the home longer than 5 years and 9 months, there’s a chance you might refinance your mortgage or move unexpectedly so take those factors into consideration when making your decision. If you are taking out a mortgage in an unusually low interest rate environment (lower chance you’ll refinance) and plan on living in the house for 10 years, you should seriously consider paying the discount point.
At Bundle, we recommend that you stay in your home for at least 4 years to offset normal swings in the housing market and to spread your closing costs over a longer period of time.
Read more on monthly mortgage mortgage payments here.
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