Mortgage lenders charge borrowers points as a part of the home-purchasing process.
A point is a fee equal to 1 percent of the loan amount. So, for a 30-year fixed-rate $100,000 mortgage, one point would cost $1,000.
There are two kinds of points: origination points and discount points. Origination points are charged by the lender and cover the cost of making the loan. For a VA loan, the origination fee is capped at 1 point, or 1 percent of the loan amount. Origination points are not tax deductible.
Buy Points, Lower Your Rate
Discount points are essentially prepaid interest on the loan. And because they’re interest paid on a mortgage, discount points are tax-deductible. You buy discount points to lower your mortgage rate, typically by 0.25 percent per point.
So let’s say that 30-year fixed-rate $100,000 loan has a rate of 6 percent. If you bought 3 points for $3,000, your rate would drop to 5.25 percent.
Deciding whether to buy discount points generally hinges on how long you plan to stay in the house because it takes time for the savings to build. Sticking with the same example, without discount points the monthly mortgage payment would be $599.55. If you were to buy 3 points, your payment would drop to $552.20.
You’re saving money each month, but you have to make up the $3,000 you spent up front on the discount points. Are the points worth it? One way to gauge is divide the cost of the points ($3,000) by the monthly savings ($47). That gives you 64, which is the number of months it will take to recoup the investment.
That’s a little more than five years.
Decision to Make
So if you’re planning on living in your home for a short amount of time, discount points could be a negative investment. But a more long-term commitment could mean points are the right move.
It’s a good idea to discuss your options with a loan officer and even take a look at an online mortgage calculator to determine your best course of action. Sometimes a larger down payment will work better than buying mortgage points, and you need to look carefully at your situation before deciding.