Buying Points to Lower Your Refinance Rate
Points, also known as “discount points,” are fees paid directly to the lender at closing in exchange for a reduced 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 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:
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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 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.
- 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 might impact your specific tax situation.
- Points for adjustable-rate mortgages (ARMs) typically provide a discount on the loan’s start-rate during the initial fixed-rate period. Run the numbers to ensure that your break-even point occurs well before the fixed-rate period expires. For example, on a 5/1 ARM, you would typically want to recoup your costs within two years which leaves three years of both a reduced payment and an increased contribution toward your principal balance each month. If rates go up during the adjustable period, your rate will be lower than it would have been by the amount of the initial rate discount you received by paying points.
Is buying points right for you?
Buying points to lower your rate may make sense if:
- you’re selecting a fixed-rate mortgage
- you plan on owning the home after you’ve reached the break-even period
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.