Mortgage rates remain low by historical standards – ask any Baby Boomer about double-digit interest rates in the 1970s and 1980s – but they are climbing upward. So someone shopping for a house might be thinking it’s smart to buy discount points to get a lower interest rate for the life of the loan.
But is it?
When you talk to your mortgage broker, there will be talk of points. One mortgage point equals 1 percent of the total loan amount – not the purchase price of the house. You can expect to pay one origination point, which is paid to the lender for evaluating, processing, and approving your mortgage.
The variable in getting a mortgage is paying a discount point. When you buy a discount point you are pre-paying a portion of your interest. You are giving the bank some its money now in return for a lower interest rate. The amount of the discount will vary with the bond market. But, a rule of thumb is each discount point will lower your mortgage by about 0.25 percent
The math needed to figure out when you break even is pretty basic. Simply divide the cost of your points by the amount you will save each month. A chart developed by Wilmington Trust Company gives a good example of the breakdown.
Again, the break-even point will vary. It could be 26 months. It could be 60 months. It’s important to know the break-even point and how long you will live in the home.
A study released in 2006 concluded that only 1.4 percent of borrowers who purchased points held their loans long enough to make it pay off. The authors looked at 3,785 mortgages originated over seven years, looking at the points paid, interest rates and loan length.
The study covered a time period of declining rates when many people may have refinanced to get a lower rate.
If you think you’ll stay in the house a long time – and you think mortgage rates will be rising in the coming years – buying discount points makes sense. If you have the cash. Don’t pay $2,000 for discount points and then use your credit card – and pay 18 percent interest – to buy $2,000 in new furniture for the new house.