Pay an extra fee at closing to reduce your mortgage interest rate.
What are Discount Points?
Discount points, a.k.a. mortgage points, are used to lower your interest rate, which in turn lowers your monthly payment. Each “point” typically equals 1% of your total home loan and reduces your rate by 0.25%. They’re like prepaid interest you pay at closing if you choose to buy them. Be aware, these numbers vary and are dependent upon your financial standing (e.g., credit score) and loan amount. “Buying down the rate” with discount points can essentially save you tens of thousands of dollars over the life of the loan. Here’s an example:
Loan Amount: $400,000 | |||
Interest Rate | 6.00% | 5.75% | 5.50% |
Points | 0 | 1 | 2 |
Cost | N/A | $4,000 | $8,000 |
Monthly Payment | $2,398 | $2,334 | $2,271 |
Monthly Savings | N/A | $64 | $127 |
Break-Even | N/A | 63 Months | 63 Months |
Total Savings | N/A | $19,008 | $37,737 |
Numbers vary across lenders and credit scores. Scenario displayed for illustrative purposes only. | |||
Will You Break-Even?
Break-even refers to the point at which the cost of the points and amount you save are equal. In the example above, if you buy two points for a $400,000 loan amount, you have an upfront fee of $8,000 you pay the lender. Your break-even point would be how long it takes to recoup the $8,000 that you spent to “buy down” the rate – in this case, that would be 63 months.
Is it Worth It?
Discount points are worth it if you’re buying a home you plan on staying in for a while. You wouldn’t, for example, want to buy points for a 5/1 ARM you intend on selling before the 5th year. If you plan on keeping the home beyond the break-even point, it’s probably worth spending the extra amount at closing, assuming your budget and finances allow.
Are Discount Points Tax-Deductible?
Discount points are usually deductible as home mortgage interest – an itemized deduction, which you can claim on a Form 1040.
How to Deduct Points
- Your lender will send you a Form 1098 – this shows how much you paid in mortgage points and mortgage interest
- Transfer the amount to line 10 of the Schedule A of Form 1040
- If you don’t see any of your points included on Form 1098, enter the additional amount paid to line 12 of Schedule A of Form 1040
Keep in Mind
- Discount points are only available at closing.
- Always ask to see an interest rate with zero points. Some lenders may add discount points to show you an attractive rate.
- Discount points are optional, and there is no limit to how many you can buy.
- Only buy discount points if you’re planning on owning the home past the break-even point.
Bottom Line
Buying points can save you tens of thousands in interest. However, they tend to be costly – the more you borrow (loan amount), the more you’ll spend per point. Deciding whether or not this is the right strategy for you is dependent upon your financial goals. The right person to ask is your Mortgage Advisor. They’ve been through all the scenarios and can give you the best options for your financial situation.