When it comes to refinancing or purchasing a home, you might have the option to buy down the interest rate using discount points—or prepaid interest on the mortgage loan. A point is a fee equal to 1 percent of the loan amount. For example, a 30-year, $150,000 mortgage might have a rate of 7 percent but come with a charge of 1 point (or $1,500). Borrowers typically can pay anywhere from 0 to 3 or 4 points, depending on how much they want to lower their rates. Discount points are tied to the interest rate; the lower the rate, the higher the total closing costs and discount points, while a slightly higher rate offers lower closing costs. Discount points also are tax-deductible. Here, some questions to ask if you’re thinking about using discount points to decrease your interest rate.
How long do you plan on staying in your home?
If you plan on moving in less than five years or refinancing again due to having a higher rate, you probably don’t want to pay discount points.
Did you purchase with a lower down payment?
If you put less than 20 percent down, you’ll likely end up paying private mortgage insurance (PMI). Once you have 20-percent equity, you might want to refinance to get rid of the PMI. Depending on where the property is situated, certain properties have a high appreciation rate, allowing you to dispose of the PMI quicker by refinancing.
Were your credit scores lower at the time you purchased? This probably caused you to have a higher interest rate. So, you’ll be more likely to consider refinancing to obtain a lower rate once your scores have improved.
Do you have out-of-pocket costs?
If you have a certain amount to work with for the down payment and closing costs, choosing the option with discount points will cause your overall closing costs to increase. Choosing an option with no discount points will minimize your closing costs.
