Experienced bargain hunters know that some discounts can snag you serious savings while others simply aren’t worth the trouble. Instead of immediately jumping on board at the first sign of possible savings, they take the time to do their homework and figure out how things really work. That way, they can decide whether chasing after a deal is actually worth the effort. A home purchase is certainly a major acquisition, so there’s plenty of pressure to secure the best deal, but it’s not the time for impulsive moves. How do discount points work? Should you be shopping for them?
How Do Discount Points Work?
If you want to understand how discount points work, you’ll first need to know exactly what they are. Then, it helps to understand the benefits that buying discount points can offer. Finally, you’ll want to know how to figure out if buying these points makes sense for you.
Defining Discount Points
As Investopedia explains, discount points are a type of prepaid interest that borrowers can opt to purchase in order to secure a lower interest rate on their mortgage. Sometimes called a mortgage point or simply a point, each discount point typically costs about one percent of the loan amount and lowers the loan’s interest rate by either one-eighth or one-quarter of a percentage point, depending on the lender. Because they’re considered a form of mortgage interest, you may be able to deduct the discount points that you purchase at tax time if you itemize.*
Discount Points vs. Origination Points
Technically, discount points aren’t the only type of mortgage points. If you aren’t aware of this, it can occasionally be cause for confusion. Once you know, you can normally tell the difference, but you should never hesitate to ask for clarification if there’s any doubt in conversations with your lender. As SmartAsset indicates, the differences between the two types of mortgage points are clear:
- Discount points. An optional purchase, these points offer borrowers a way to secure a lower interest rate.
- Origination points. A mandatory fee, these points cover the lender’s expenses while processing the loan. They are considered part of the closing costs.
Benefits of Discount Points
Buying discount points is sometimes referred to as buying down the rate, which offers a sizable hint about the major benefit to purchasing points. As The Balance reports, a lower interest rate on your home loan can generally save you money a couple of different ways. For starters, it normally means that your monthly mortgage payment will be a little lower because a chunk of your monthly payment goes to paying off the interest. In addition, your interest rate has a major impact on the total cost of your loan, so securing a lower interest rate means that you’ll ultimately be able to pay less for your home.
Deciding If Discount Points Make Sense for You
Since discount points are an optional purchase, buying them is a choice. How do you decide if buying them is a sensible choice in your situation? As CreditKarma points out, a lot depends on how long you plan to stay in the home. Generally, discount points are more likely to pay off if you plan to remain in a home for a longer period of time. How long will you need to stay for it to be worth it? To find out, you can do a little math. Take the amount that you’ll spend to purchase points. Then, divide it by the amount you’d save each month thanks to your lower interest rate. The result will tell you how many months you’ll have to stay in the home to break even on your purchase of the points. Any additional time that you stay there will result in savings.
How to Buy Discount Points
As Investopedia notes, discount points are a limited-time offer. You have to make up your mind before closing. Discount points are paid for at the closing table. You may be required to pay for them upfront, or you may be able to roll them into your loan.
How do discount points work? Should you put them to work for you? The loan experts at PrimeLending Kansas City will be happy to sit down with you to help you sort through the pros and cons so that you can feel confident about your decision. Contact us today to get started.
*PrimeLending is not authorized to give tax advice. Please consult your tax adviser for tax advice for your specific situation.