When you take out a mortgage to buy a new home, you may have the option to purchase discount points. If you buy one point, you’ll have to pay a fee equal to 1% of the loan amount directly to your lender.
In exchange, you’ll get a reduction in the interest rate. The amount of that reduction will depend on your lender. Buying discount points may or may not be a good idea, depending on your individual circumstances and how long you plan to stay in the house.
Purchasing Discount Points Can Save You Money
If you buy one or more discount points, that will reduce your interest rate, translating to lower monthly payments. Purchasing points can make a mortgage more affordable and give you more money in your monthly budget to devote to other priorities, such as saving for retirement.
You May or May Not Break Even If You Buy Discount Points
The savings you’ll enjoy by getting a lower interest rate will grow over time. If you expect to live in your house for a long time, buying mortgage points may be a good idea. If you’ll probably move relatively soon, you may not save enough in interest to make the initial payment for points worthwhile.
Divide the cost of points by the amount you can save each month to figure out how long it will take for your savings to equal the upfront cost. If you don’t expect to live in the house for too long, it doesn’t make sense to buy points.
If you take out an adjustable-rate mortgage and buy discount points, the reduction in the interest rate may only apply in the initial period before the rate resets. If you won’t break even before then, don’t pay extra for points.
You May Be Better off Making a Bigger Down Payment
If you put down less than 20%, you’ll most likely have to purchase private mortgage insurance, which may add hundreds of dollars per month to your housing costs. If you pay for points to lower your interest rate, the amount you’ll save may be more or less than the cost of PMI.
If it will take several years to break even after buying points, it may make more sense to make a larger down payment and avoid PMI. You’ll need to look at the cost of the house you want to buy, your interest rate and the total amount of money you have to work with to figure out if buying points or making a larger down payment is the better option.
