suburban neighborhoodIn order to get the best rate on a mortgage purchase or refinance, you should consider purchasing mortgage discount points, which will allow you to lock down a lower interest rate. Discount points are a form of interest that is paid at closing; each point equals 1% of the total loan amount. In other words, if the amount of your loan is $150,000, one point would cost you $1,500 at the time of closing. At first glance, the idea of paying more in closing costs may seem outrageous, but when you look at the long-term advantages of mortgage discount points, you may find that they’ll save you big bucks over the life of your loan. Let’s take a look at the benefits of mortgage discount points to find out if they’re right for you.

Perks of the Discount Points

Mortgage discount points are all about playing the long game. Let’s use a $150,000 loan as an example to illustrate the long-term benefits of discount points. If you want to plug in your own numbers, check out these handy calculators from Quicken Loans.

Loan Amount: $150,000 for 30 years

Points Interest Rate Monthly Payments
0 4.125% $727
1.25 3.875% $706
1.75 3.75% $695

 

If you purchase 1.75 mortgage discount points (with a point costing 1% of the loan amount), it will cost you $2,625 at the time of closing. This may seem like a hefty amount on top of your down payment and other closing costs, but consider how this low interest rate will benefit you over the course of the loan. If you decide not to purchase any mortgage discount points, then the total amount of your loan at the end of 30 years will be $261,700. But if you purchased 1.75 mortgage discount points, your total amount paid will be $250,000.

If you subtract the original cost of the 1.75 points ($2,625), you would still be saving $8,895 over 30 years. And even if you don’t stay in your home for 30 years, you’ll break even in about seven years. So, as long as you’re planning on living in your home for more than seven years, you should consider purchasing mortgage discount points.

Are Mortgage Points Right for Me?

While mortgage discount points are an excellent choice for some clients, they’re not right for everyone. As mentioned in the example above, the length of time you stay in your home is one of the most important factors. If you’re a wandering soul and you only plan to live in your house for a few years, it’s probably a better decision to pay lower closing costs and higher monthly payments.

Another aspect to consider is private mortgage insurance (PMI). As long as your down payment on a mortgage is under 20%, you’ll be required to pay PMI, which typically costs about 1% of the loan amount. In the case of a $150,000 house, this means the PMI will cost $1,500 a year or $125 a month.

This is important for clients who are on the fence between paying for mortgage discount points or a larger down payment. If it’s between discount points and boosting your down payment to 20% or over, you’ll want to choose the down payment most of the time. Always do the math and consider if your discount points are costing you more or less than your monthly PMI fees.

Take the Points; Invest the Surplus

If you decide to purchase mortgage discount points, you should also consider investing the excess money that you save every month. Let’s say you decide to purchase 1.75 mortgage discount points on your $150,000 loan, meaning your monthly payment is $695. This means you’ll have a monthly savings of $32. If you take that $32 and invest it month after month, then by the end of the 30-year period (assuming a 7% interest rate), you will have $38,812.10. This far outweighs the initial $2,625 cost during the initial purchase of the points.

Once again, this option is all about the timing. If you only have your home for seven years, and you invest your excess funds during that time, you’ll only be getting about $3,500 out of your investment. At that ROI, you would be better off not paying for points at all and investing your initial $2,625. In the same seven years, this would produce about $4,200.

Tax Benefits

There are also tax benefits that come along with purchasing points. Points are considered prepaid interest, so they may be deductible as home mortgage interest, but you’ll to need to fill out Form 1040, Schedule A and itemize these deductions. Check out Topic 504 – Home Mortgage Points from the IRS.

The Discount Point Decision

Deciding if discount points are the right decision for you can be a tricky part of the mortgage process. If you want to learn more about which option is best for you, contact a Home Loan Expert at Quicken Loans. They’ll be sure to point you in the right direction.

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