September 18, 2015 - 4:24 pm
Q: What are mortgage points?
A: A point is 1 percent of your loan amount. If you take out a $250,000 mortgage, 1 point equals $2,500.
There are two types of mortgage points:
• Origination points are a fee you must pay a bank or mortgage company to give you a loan.
• Discount points (the most common type) lower the interest rate on your loan and reduce your monthly payments.
Borrowers get a lower rate for paying discount points because they’re prepaying a portion of the interest on their loan.
Indeed, discount points are tax-deductible, just like the interest you pay with each monthly mortgage payment. (According to the IRS, 2.7 million of the 45.5 million federal tax returns filed in 2012 took a deduction for discount points.)
Q: How much can you lower your interest rate by paying points?
A: Anywhere from one-eighth to one-quarter of a percentage point per discount point. A range like that makes it absolutely critical to compare offers that include points to those that don’t and determine how much you’re really saving by paying thousands of extra dollars up front.
Some banks and mortgages companies actually promote interest rates in their advertising that are only available by paying points. They hope you’ll be so wowed by a rate that looks like it’s lower than competitors are charging that you won’t notice the additional up-front cost.
Q: Should I lower my interest rate by paying discount points?
A: Paying points to get a lower rate on a mortgage is almost always a losing proposition. That’s because most homeowners don’t keep their mortgages long enough to do more than recoup the up-front cost of paying points. The key question you need to ask is: How long will it take me to recoup what I spend on points through lower monthly mortgage payments?
Consider two typical 30-year fixed-rate mortgages quickly shows how much paying a point will save (or cost) you on a typical $100,000 mortgage.
• Mortgage Option 1: 4 percent interest rate with no points
• Mortgage Option 2: 3.875 percent interest rate with 1 point
If you pay 1 point, or $1,000, to get the 3.875 percent rate, you lower your monthly payments by right at $10 a month. That means it would take 100 monthly payments, or more than eight years, to recoup the up-front cost of that point.
You won’t really start saving any money until then — and therein lies the problem. Chances are you won’t keep your loan much longer than that since the typical homeowner pays off his loan in just over eight years, according to data compiled by Bloomberg News.
Selling or refinancing before the break-even point means you’ll actually wind up paying extra interest on the loan.