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Tuesday, October 31, 2006

Should You Pay Mortgage Discount Points?

Should you pay discount points when you get a mortgage?  To answer that question, you need to estimate how long you will keep the mortgage past the break-even point.  The break-even point is the time when your accumulated savings exceeds the amount you paid in points.

Mortgage discount point defined
Lenders say that a lot of customers, especially first-time homebuyers, don’t understand the concept of discount points and feel reluctant to ask.  One discount point is an upfront payment of 1 percent of the loan amount paid at closing.  You receive a reduction in the interest rate in exchange for paying discount points.  You end up with a lower monthly mortgage payment.

Discount points are based on the loan size, not the purchase price.  If you borrowed $200,000 to buy a $300,000 house, one point would cost 1 percent of the loan amount, or $2,000.  Two points would cost $4,000.  Paying discount points does not reduce the amount borrowed.

As a rule of thumb, a mortgage’s interest rate is reduced by a quarter of a percentage point for every discount point you pay.  That’s just a rough guide, though; the actual amount of the discount varies by lender and can fluctuate in response to movements in the bond markets.  One day a lender might drop the interest rate by a quarter-point in exchange for a discount point; the next day, the same rate reduction might cost only a half point.  Most lenders give the option of paying anywhere from half a point to four discount points or even more.

Estimating your break-even point
To find out if you will hold the mortgage past the break-even point, you must have a notion of how long you will keep the mortgage.  If you plan to sell the house or refinance within two years, it probably doesn’t make sense to pay discount points.  On the other hand, if you plan to keep the house for 10 years or more, you will save money in the long run by paying points.

You should ask your lender how much money is saved each month for every point paid.  For example, if you paid $1,000 in points and it saves you $15 a month on your mortgage payment, it would take you 66.7 months to break-even for paying for the point.

My calculations show that, on average, a no point loan makes sense if you plan to keep the mortgage only 3 years.  If you hold the loan 3 to 6 years, it makes sense to pay half a point and past six years to pay a full point.

Feel free to give me a call anytime.

Contributed By: Greg Glover Loan Officer Spectrum Financial Group 7047 E. Greenway Pkwy., Suite 400 Scottsdale, AZ  85254 Phone: (480) 603-1682 Email me

Posted by Greg Glover on October 31, 2006 | Permalink

Comments

YOu are correct, most people trip over the amount that buying down points will cost them and how long it will take to recover their basis point purchase.

Withth e average owner doing a refi every 3-5 years unless it will save them money over that time period it isn't worth it IMO.

Posted by: Randall Wall | Dec 26, 2006 4:55:22 PM

Good article- I explain this to all of my clients and it's a shame all mortgage people don't.

Posted by: RJ Baxter | Feb 2, 2007 7:46:58 AM

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