Should I Pay Discount Points on My Mortgage?

Mortgage discount points (also referred to as points) are an upfront fee paid to the lender. One point equals 1% of the loan amount.

Borrowers often have a choice. They can pay points to get a lower interest rate, or they avoid the charge for points and accept a higher interest rate. This case study shows how to evaluate your options.

Mortgage Discount Point Questions

When a borrower decides whether or not to pay points, he/she might consider a number of questions, such as:

• How much (if anything) will I save by paying points?
• What is the payback period (i.e., the time required to recover the cost of points)?
• What is the upfront cost (paid at settlement)?
• What is the monthly cost for principal and interest?

This site's mortgage calculator makes it easy to answer these questions. The following case study illustrates the process.

Discount Points or Down Payment?

Bob needs a $300,000 mortgage to buy his new home. The lender is offering two options.

• Option 1: Fixed-rate mortgage, 30-year loan term, 8% interest, no points.
• Option 2: Fixed-rate mortgage, 30-year loan term, 7.5% interest, 2 points.

Option 2 requires that Bob pay 2 points. This amounts to 2% of the loan or $6,000. Bob wonders whether he would be better off to make a $6,000 down payment on the principal (thus, reducing the loan amount to $294,000). Bob decides to test both options, as shown below.

To compare the options, Bob uses the Mortgage Mavin calculator. The first step is to describe the analysis he wants to conduct.

• Choose "Compare two mortgages" from the Main Goal dropdown box of the calculator.
• Under Loan 1, choose "Fixed-Rate Mortgage" as the mortgage type.
• Under Loan 2, choose "Fixed-Rate Mortgage" as the mortgage type.
• Be sure the "Show amortization schedule" checkbox is checked.

The calculator then configures itself to accept the data it needs, and Bob enters data from the above table into the calculator. The calculator settings and data entries are shown below.

After Bob clicks the Calculate button, the calculator generates many useful results. Some key findings appear below. Note that the second table is a screen shot of months 67 to 71 from the amortization schedule.

Based on the above results, we know the following:

• Savings. Over the full term of the loan (30 years), Option 2 (the points option) reduces the total mortgage cost by $21,457.45.
  
  
• Payback period. The amortization schedule shows that the total cost of Option 1 is less than the total cost of Option 2 for the first 68 months of the mortgage. In month 69, Option 2 becomes the less expensive choice. Therefore, the payback period would be 69 months.
  
  
• Upfront cost. Both options have the same upfront cost - $6,000. For Option 1, $6,000 is used as a down payment; and for Option 2, it is used to pay points.
  
  
• Monthly payment. Option 2 has the lower monthly payment - $2097.65 versus $2157.28

Based on these findings, the option that Bob should choose would depend on how long he intended to live in his new home. If Bob lived in the home for less than 69 months, he should choose Option 1 (the no-points option); since it would be less expensive over that time period. However, if Bob planned on living in the home for 69 months or more, he should choose Option 2 (the points option); since it would be less expensive over that time period.

Points or No Points?

Note that Bob might have also evaluated Option 1 (the no-points option) without making a $6,000 down payment. The inputs to that analysis are shown below:

After Bob clicks the Calculate button, the calculator produces many results. Some key findings plus months 46 to 50 from the amortization schedule are shown below.

Based on the above results, Bob draws the following conclusions:

• Savings. Over the 30-year life of the loan, Option 2 (the points option) is less expensive, reducing the total mortgage cost by $31,313.08.
  
  
• Payback period. The amortization schedule also shows that the total cost for Option 1 is less than total cost for Option 2 during the first 47 months of the mortgage. In month 48, Option 2 becomes the less expensive choice. Thus, the payback period for Option 2 is 48 months.
  
  
• Upfront cost. Option 1 requires no down payment; whereas Option 2 requires a $6,000 payment to cover points.
  
  
• Monthly payment. Because Option 2 has the lower fixed interest rate, it has the lower monthly payment - $2097.65 versus $2201.30

In this case, Bob's choice would probably depend on two factors - (1) the length of time that Bob intends to stay in the home and (2) the importance to Bob of minimizing upfront mortgage costs. If Bob were going to stay in the home less than 48 months, he should choose Option 1 (the no-points option). If Bob were going to stay in the home longer, he should weigh the potential long-term savings against the increased upfront cost.