Paying Points to Lower the Rate

Two commonly known ways to lower your mortgage payments are to make a larger down payment especially if it eliminates private mortgage insurance and improve your credit score before applying for a mortgage.

Another way to lower your payment would be to buy down the interest rate for the life of the mortgage with discount points.  A discount point is one percent of the mortgage borrowed.  Lenders collect this fee up-front to increase the yield on the note in exchange for a lower interest rate.

A permanent buy down on a fixed-rate mortgage is available to borrowers who are willing to pay discount points at the time of closing.

Let's look at two options on a $315,000 mortgage for 30 years at 4% interest with no points compared to a 3.75% interest rate with one-point.  The principal and interest payment on the 4% loan would be $1,503.86 compared to $1,458.81 on the 3.75% loan. 

The $45.04 savings is available because the buyer is willing to pay $3,150 in points.  By dividing the monthly savings into the points paid, you can determine the breakeven point.  In this example, if the buyer is planning to stay in this home for at least 70 months, they would recapture the cost of the points and each month after that would be savings.

Another interesting thing to consider is that lower interest rate loans amortize faster; in other words, they build equity faster by paying off the loan sooner.  If the buyer stayed in the home for 10 years, their unpaid balance in this same example would be $2,117.38 lower than the 4% mortgage.  Combine that with the $2,259.29 in savings from the breakeven point to the end of 10 years and the buyer, in this situation, is $4,372.67 better off buying down the mortgage by paying the additional points. 

For a person buying a home, it may be difficult to come up with the extra amount for the points but one benefit is that the points paid are considered interest by IRS and can be deducted in the year paid.

A rule of thumb commonly used is that one discount point lowers the quoted mortgage rate by ¼% or 25 basis points.  A lender may quote X% + .6 points for a mortgage.  Using this scenario, to lower the mortgage rate by .25%, the buyer would need to pay 1.6 points. It is important to note that each lender determines the pricing of points for the loans they make. 

It may be beneficial to a buyer to pay points depending on how long they plan on being in that home.  To help you determine whether paying points should be considered, use this Will Points Make a Difference and download the Buyers Guide