Many home buyers are foggy about discount points. What are they, how do they work and why would you want them?
What are discount points?
A discount point is a sum of money that borrowers can use to purchase a lower interest rate on their home loan. The easiest way of thinking about discount points is that they are pre-paid loan interest. You are essentially buying a lower interest rate at the beginning of your loan, so they are also often referred to as ‘buydown points.”
How are they calculated?
One discount point is equal to 1% of the borrowed amount. Assuming that a loan is $200,000, one discount point would be $2000 and .25 discount points would be $500.
As a rule of thumb, paying one discount point will reduce your mortgage rate by .25%. However, paying 2 discount points will not reduce your mortgage by .50% (or 3 by .75% and so on). Exactly how much the interest rate on your loan will drop (when using more than one discount point) will vary by bank, time of year and projected volume that loan may be “sold” for. Talk to your loan officer about these rates.
Why would you want to pay discount points?
- Paying points will give you a slight monthly savings, and in the long run the savings on interest adds up to thousands.
- Because mortgage interest is tax deductible and discount points are inherently interest, they too can be 100% tax deductible in conjunction with a home purchase.
- Some employers offer to pay some discount points as an employee incentive.
- Discount points can be negotiated into the contract as a seller concession.
- If you are planning to move within a few years, paying discount points may not be a wise investment of your money.
Points can work in reverse.
Rather than paying them, they can be tacked on to your loan to create extra money to spend. Lender-paid closing costs loans work this way. Basically, you’re borrowing a bit more money at a slightly higher interest rate.
For more answers and advice about discount points, contact one of our knowledgeable Realtors® at 301-759-0100.