Mortgage Loan Discount Points: What Are They and Why Should You Care?
The concept of mortgage points can be confusing. “Paying points” might sound like just another way to get money out of you, and it adds another layer of complication to an already complex decision-making process. So let’s take a moment to try and make sense of mortgage discount points, plus look at why some borrowers might want to pay them.
What are mortgage points?
A mortgage discount point refers to 1% of the total mortgage amount. One point on a $500,000 home loan would be $5,000, so two points would be $10,000, and so on. But what do these mortgage points do for you? In short, they save you money in the long run.
When you buy mortgage points, you’re essentially paying interest ahead of time. Paying mortgage points reduces your interest rate; usually a 0.25% rate reduction for every point you pay. So, two discount points on a $500,000 mortgage with a 4.5% interest rate would cost $10,000, which is payable at closing. And this would reduce the annual interest rate from 4.5% to 4%, reducing the monthly principal and interest payments from about $2,533 to $2,387.
But is saving $146 per month worth paying an additional $10,000 at closing? Why not just put that same $10,000 toward the down payment?
Why mortgage points matter
While $150 may not seem like a big difference when your mortgage payment is just over $2500, you have to make the cost-benefit analysis over the long term. Paying for discount points isn’t something that’s recommended for a borrower who only plans to live in a house for a few years.
For example, the total cost of a $500,000 loan at 4.5% over 30 years would be $912,034. But if the borrower paid $10,000 for two points to discount the rate to 4%, the total cost drops to $859,348. That’s a savings of $52,686 — a whopping fourfold return on their investment in discount points.
This isn’t an investment plan. If you’re a serious investor and you’re confident you can make more money than you can save by purchasing mortgage points, that’s a better move. But for many long-term homebuyers, mortgage discount points are a wise choice.
Buying points vs. making a bigger down payment
But what about putting the extra money into the down payment? Doesn’t reducing the principal also reduce the total interest paid and the overall cost of the loan?
Looking at the same $500,000 mortgage: if the borrower was to pay an additional $10,000 down, it would reduce the mortgage amount to $490,000. At 4.5%, the monthly payment would be about $2,483, and the total cost of the loan over 30 years would be $893,793.
In other words, adding $10,000 to the down payment would save the borrower only $18,241, instead of more than $50,000 in savings if they had used the same money to purchase mortgage points.
Discount points aren’t offered on all mortgages, but they can save you thousands if you use them wisely. If you aren’t sure if they are right for you, consult a qualified mortgage professional.
Are you wondering whether mortgage discount points are right for your situation? Contact Torrance Mortgage Lender Shawn Carvin today for a free analysis. Shawn is a licensed California mortgage professional with nearly 30 years experience in the financial services industry, half of that focused on mortgage lending. Shawn works with clients throughout the greater Los Angeles area including Torrance, the Palos Verdes Peninsula, the Beach Cities, other South Bay communities, and beyond.