Decoding Mortgage Discount Points: Is It Worth It for You?
The Federal Reserve raised interest rates eleven times between 2022 and 2023. As a result, buyers are running through the playbook in an effort to secure the best possible rate.
Mortgage interest points, or discount points, recently gained traction as a popular strategy, but like any financial decision, there are advantages and drawbacks to consider.
Understanding Mortgage Interest Points
Mortgage interest points are a form of prepaid interest, giving buyers the option to pay more upfront at the time of closing in exchange for a reduced interest rate over the life of the loan.
By paying points, you pay more upfront but can receive a lower rate in the long term, which also helps reduce your monthly payment.
Each point typically costs 1% of the total loan amount and can take between 0.125% and 0.25% off the interest rate.
However, if you expect to move or refinance in the near future, you may not save enough on your monthly payments to recover that expense.
Recent Spike in Borrowers Paying for Discount Points, According to Freddie Mac
According to the 2024 Economic, Housing and Mortgage Market Outlook report published by Freddie Mac, more than half of US borrowers paid discount points last year, a substantial jump from recent years, in an effort to combat elevated home prices and mortgage rates in the 7% range.
The report detailed a recent spike in popularity for the strategy, noting that approximately 59% of purchase borrowers paid discount points in 2023, compared with 31% and 54% of purchase borrowers in 2021 and 2022.
Pros of Mortgage Discount Points
> Lower interest rate
> Lower monthly payments (as a result of a lower interest rate)
> Can make a larger loan more affordable
> May be tax deductible
Cons of Mortgage Discount Points
> Can increase closing costs
> Uses money that could have gone toward the down payment, if paid upfront
> Won’t build equity in the property
> Will likely take multiple years to break even on the cost
When Are Mortgage Interest Points Worthwhile?
While mortgage interest points may not be suitable for everyone, there are scenarios where they can prove advantageous.
If a buyer needs to lower their monthly interest cost to make homeownership more feasible, points could be a viable option.
Similarly, for individuals with credit scores that don't qualify for the lowest available rates, points may help secure a more favorable mortgage.
Buyers seeking upfront tax deductions or those who intend to stay in their home long-term may also find the strategy worthwhile.
Alternatives to Mortgage Interest Points
If you are in the market for a home and are looking for ways to reduce your costs or lower your mortgage rate, consider these options:
Make a larger down payment: A larger down payment may help lower your overall interest rate.
Improve your credit score: Higher credit scores typically bring lower interest rates and more favorable terms. To raise your credit score, be sure to review your credit reports, pay off your debts, and manage your credit utilization.
Budget for extra monthly payments: For long-term savings, consider setting up an extra recurring monthly payment to help pay off your mortgage early and save money on interest. Consider strategies like making an extra fixed payment every month or rounding up your monthly payments to the next $100 value.
Closing Thoughts
Mortgage discount points are a viable strategy for borrowers looking to lower their interest rate and save some money long-term. However, there are a number of alternatives worth exploring- especially if you would benefit from an increase in flexibility.
As always, it’s important to make an informed decision that aligns with your homeownership goals. Give us a call or visit us online to determine the best home financing strategies for you and your family today.