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Buying Points to Lower Your Rate

Points, also known as “discount points,” are fees paid directly to the Glossary Term: lender at closing in exchange for a reduced Glossary Term: interest rate. This is also called “buying down the rate,” which can, in turn, lower your monthly mortgage payments.

A point is equal to 1% of your mortgage amount (or $1,000 for every $100,000). You’re essentially paying some Glossary Term: interest up front in exchange for a lower interest rate over the life of your loan.

The general rule is that the longer you plan to own the home, the more you might benefit from buying points, because you would realize more interest savings over the life of the loan. When you consider whether points will be right for you, it helps to run the numbers. Here’s an example:

points example

Breaking even

An important thing to consider is how long it will take for the upfront cost of the points to equal the savings you get on your monthly payment. This is called the Glossary Term: break-even period.

In the example above, you’ll see that if you paid $2,000 for one point to lower your interest rate 0.25%, you’d have a monthly payment savings of $30.55. To find the break-even point, you’d divide $2,000 (the upfront cost) by $30.55 (the monthly savings), to see how long you’d have to live in your home for it to be worth the upfront cost. In this example, it would take 65.4 months to recoup the initial cost.

Considerations:

  • The interest rate reduction you’ll receive for buying points can vary widely, depending on the lender and the marketplace.
  • Buying points may give you a tax benefit. Contact your tax professional to see how buying points would impact your specific tax situation.
  • When buying a home, you will avoid the cost of Glossary Term: private mortgage insurance (PMI) by making a Glossary Term: down payment of at least 20%. If you need to decide between making a 20% down payment and buying points, run the numbers to see if paying PMI would cancel out the savings you’d get from buying points and lowering your interest rate.
  • Points for Glossary Term: adjustable-rate mortgages typically provide a discount on the loan’s initial fixed-rate period only, not the remaining term of the loan when the interest rate becomes adjustable. For this reason, it’s unusual to buy points on an adjustable-rate mortgage.

Getting help paying for points

Sometimes new home developers will offer to pay for points as an incentive to potential homebuyers. This can work to your benefit, particularly if you’ll be in the home for a long time. In addition, just as you may negotiate with a seller to pay your Glossary Term: closing costs, you may ask a seller to pay for your points. This could save on the amount of cash you will need at closing. There are limits to “third party” contributions, so ask your lender for guidelines for the program you are considering.

Is buying points right for you?

To find out whether points could work for you, determine if you have the cash available to buy points up front in addition to your down payment, closing costs, and Glossary Term: reserves. Also, consider how long you plan to own the home.

Buying points to lower your rate may make sense if:

Deciding how to best use your home savings is a personal choice. Now that you’re armed with a better knowledge of how points work, ask your lender to provide you with more information to help you decide whether they could work to your advantage.