Discount points can lower your payment if you stay long enough

Discount points won’t help if you leave or refinance

Buying a is a process that most Americans find tedious and time consuming. It can take months to get loan approval and unless you work in the business, you may find all of the terminology frustrating. But most people understand the basics - you will borrow money from a lender who will expect you to pay it back, with interest, over a certain point in time. That interest rate is usually agreed upon ahead of time, so when you sign on the dotted line, you know how much you will be expected to repay.

A twist on this is the notion of discount points.  In essence, for a fee, the lender will lower the interest rate that they charge you for the loan. The amount of the discount will vary with fluctuations in the market, but on average, you will receive a discount of about one quarter of one percent on the interest rate in exchange for an upfront payment of one percent of the loan amount. For example, if the lender is offering you a loan at 6.25% on a $150,000 loan, they may lower the rate to a flat 6% in exchange for a payment of $1500 at closing. This one percent fee is known as a “point” and those paid as part of closing costs to reduce the mortgage are known as “discount points.”

If you are offered discount points, should you buy them? That depends. First of all, if you aren’t offered them, ask if they are available. You want to have all the information about loan options before you sign. After that, you need to look at the amount of possible reduction, the price in points, and you need to have some idea as to how long you will be holding that mortgage. After that, it is all a matter of simple math.

Simply ask your lender to show you how much buying a reduction will lower your payment. If it costs you $2000 to lower your payment by $20, then you must keep the loan for 100 months, or a little over eight years, in order to recoup your investment. If you stay longer than that, then you have chosen wisely. If you should move or refinance sooner, then you will lose money. It’s that simple. All you need to do is figure out how long you wish to keep the loan.

Many buyers will have some sort of notion as to how long they will stay in the house. The harder decision is to guess whether or not it will become necessary or desirable in the next few years to refinance the loan. As interest rates are still fairly low right now, refinancing in the near term for reasons of lowering the rate isn’t all that likely, but doing so in order to remodel the home or consolidate debt might be possible.

If you should decide that you are likely to keep the mortgage long enough to justify the cost of lowering the interest rate, then you should probably go ahead and do so. It will save you quite a bit of money over the life of the mortgage.