Making The Decision to Pay Discount Points
Discount Points are paid up front to obtain a lower interest rate on your mortgage. The more points you pay the lower the rate. Usually, one point equals one percent of the loan amount and will lower the interest rate by .25 percent, so a loan amount of $150,000 at 1 point would cost $1,500. The reason you may want to pay points is determined by the amount of time you think you'll be in the home. If you think you'll be a long-term owner, it makes sense to pay points to buy-down the rate. This will cost you a little more upfront but the long-term benefits will take effect down the road because of the lower interest rate. This however, usually can take 5 years just to reach the break even point before you realize any monthly savings.
Each borrower should be given the option to reduce the interest rate, by paying discount points; it should not be mandatory. At 1st Residential Funding we do what is in our borrowers best interest. We usually recommend that discount points are not paid unless a 3rd party is paying them on the borrowers behalf. An example of this would be if the borrowers employer is paying closing costs as a part of relocation expenses. Otherwise, it usually does not pay to "buy down" the rate with points! The average home owner is in the same house for only 5-7 years, before moving on.
To get an idea of whether or not it is worth it to pay points do the following:
Divide the amount paid in points by the amount saved by the lower monthly payment. For example, if you are borrowing $150,000 you can pay no points at 6% interest for 30 years, which is roughly $899.00 per month. Or you can pay 2 points for 5.5% rate, which is roughly $852.00 per month. Your savings per month is $47.00 ($899.00 - $852.00)
Most people don't realize it took over 5 years just to recover the cost of paying for that discount point, it may take 5 more years to save that same amount of money and in 10 years you would have saved only what you spent when you paid for the discount point.