Discount Points

Points are dollars you pay as a percentage of your loan. A common use for points is to secure a lower interest rate on your loan. By paying a little bit up front, points allow you to pay less each month. Is it worth it? Let’s find out.

How Points Work

A point is one percent of the mortgage loan amount. To use easy numbers, let’s assume that your loan will be for $100,000. In that case, one point would be $1,000 (100,000 x .01 = 1,000).

While shopping loan rates, you may find that different loans are available with and without points. You might pay anywhere from zero to three points. In our example, that means you’d pay anywhere from $0 to $3,000 up front.

Why Pay Points?

The advantage to paying points is that you can secure a lower interest rate on your mortgage loan. Because the interest rate is an important ingredient in calculating the monthly payment, you end up reducing your monthly payment by paying points.

As you plan and budget for the years to come (you are doing that aren’t you?), you may find that you’d like to have a lower monthly mortgage payment. One way to accomplish this is by paying points.

Finally, you may get some tax breaks by paying points. Depending on your transaction, you may get tax benefits in the year you pay points, or over a number of years. Check the IRS rules in Topic 504 – Home Mortgage Points.

Of course, this costs money. You’ll need to come up with a small percentage of your total loan up front. Depending on the size of your loan, this can be thousands of dollars that you don’t have. Availability of funds is a major consideration here.

Should You Pay Points?

If you can afford to pay the points, you’ll need to figure out if it’s worth it. Here’s a general rule of thumb: the longer you’ll keep the loan, the more attractive points become.

You need to consider the overall economic value. If you’re the type of person who likes spreadsheets, you can determine the optimal choice by looking at future values versus present values. However, most people start with the following route:

1. Figure out how many points you can pay
2. Find out how much any choice would reduce your monthly payment
3. Consider how many months of reduced payments you could enjoy
4. Decide whether it looks like it’s worth it

Before you actually make the decision, I recommend crunching the numbers or having your lender do it for you.

Running the Numbers

You can use one of the online quoting services to run a variety of scenarios – with and without points. By doing some “what-if” experiments, you’ll see exactly how points will affect your finances. Enterprise Bank has a very nice Points Calculator which can help you make decisions.

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