How Do Discount Points Work?

Discounts sometimes provide significant savings, but savvy shoppers know that it’s always wise to be wary. Too many supposedly fantastic bargains come with strings attached that erase the promised savings or result in a higher price tag. If you’re contemplating a home loan, you may wonder if discount points are a smart purchase. To make that determination, explore discount points in more detail. How do discount points work? What advantages do they offer? What drawbacks should you watch out for? Use the advice below for help.

How Do Discount Points Work?

As Investopedia explains, buying discount points lowers your interest rate. Each point that you purchase drops your interest rate by a specific amount. At heart, discount points are a form of prepaid interest on your home loan.

The Pros of Points

Why would you want to purchase discount points? For starters, securing a lower interest rate can substantially reduce the cost of borrowing money. And as Policygenius points out, buying discount points provides multiple opportunities to save cash:

• It lowers your mortgage payments. Part of your monthly mortgage payment goes to paying down the interest on your loan. If you’re paying less in interest, that will be reflected in your monthly mortgage payment.
• It offers a chance for substantial savings over time. Mortgages are often measured in decades. While the monthly savings that you’ll see from a lower mortgage payment may not seem massive, they’ll add up as time passes. If you continue with the same mortgage long enough, you’ll eventually save enough to equal the price that you paid for the points. After that, any additional savings are purely extra cash in your pocket.
• It might serve as a tax deduction. Since mortgage points are a form of mortgage interest, you may be able to use them for a deduction on your taxes. To find out, talk with your tax preparer.

The Cons of Points

Discount points have the potential to produce savings, but as Money Under 30 indicates, buying discount points doesn’t always make good financial sense:

• You have to keep the loan long enough to see real savings. While a smaller monthly payment is nice, it’s only smaller because you’ve already paid a portion of the interest. You don’t actually start saving money until the total of your monthly savings equals what you paid for the discount points. If you refinance or sell before hitting that milestone, you won’t see the savings that you were hoping for.
• Discount points add to the upfront cost of a mortgage. Purchasing discount points means that you’ll pay more at closing. This leaves you with a smaller reserve for emergencies and other purposes.

The Bottom Line

Is purchasing discount points the right move for you? If you’re trying to decide, SmartAsset suggests that you consider your financial situation and your plans. Purchasing points can be smart if you have the cash to do so and plan to stay in both the home and the loan for a lengthy spell. However, buying discount points isn’t the best bargain if you would have to stretch your resources to swing the purchase or only plan to be in the home for a few years.

Purchasing Points

If you decide to purchase discount points, you’ll need to pay for them at the closing table. How do lenders price discount points? As Credit Karma indicates, the cost of a point typically equals 1 percent of the amount being borrowed. Lenders handle points in different ways. Some give you the opportunity to purchase fractions of a point. Most limit borrowers to buying a maximum of three points.

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How much house can I truly afford? Which loan is right for me? How do discount points work? What do I need to bring to the closing table? Buying a home can raise plenty of questions. Turn to PrimeLending: Twin Cities for clear, accurate answers. We strive to deliver user-friendly information, expert advice, clear communication, and excellent service. Contact us today to schedule a consultation with one of our friendly, knowledgeable loan officers.