When you obtain a mortgage, there are two forms of points you may pay: discount points and origination points. Each point is equal to 1% of your loan. This means a point for a $150,000 loan is $1,500.
Origination points are actually mortgage loan officer compensation and they are not tax deductible. This fee is charged by the lender for processing a new loan application.
Discount points, on the other hand, are prepaid interest. Discount mortgage points are used to secure a lower rate, with one point lowering your rate by 0.25%. Lenders allow you to buy zero to four discount points to get a better rate and lower your payments. Unlike origination points, discount points are tax deductible.
Make sure you pay attention to advertised mortgage rates. Many will show not only the advertised rate, but also the number of discount points included in the loan quote which are paid when you close.
Should you pay discount points if you have the opportunity? This depends on two important factors.
Begin by considering your future plans. How long do you want to stay in the home? The longer you stay in the home, the more discount points will save you. Here is an example.
Option 1: $100,000 loan with a 6% rate and a $599.55 principal and interest payment.
Option 2: $1,000,000 loan with a 5.25% rate after paying 3 points ($3,000) with a $552.20 payment.
To break even in this example, you must stay in your house for 63 months.
Secondly, consider the cash reserves you have. It may not be wise to pay discount points if you will struggle with your down payment and closing costs for your loan.
Some experts will tell you that discount points are always worth it and a good investment, as most buyers simply want a home that will be affordable. Remember that buying points is usually worth it if you want the lowest payment and the most long-term savings, assuming you will stay in the home.