Offset higher mortgage rates by paying discount points

Have you applied for a mortgage loan lately? If so, you are aware of how much mortgage rates have increased over the past few months. One method of offsetting the higher rates is to pay discount points. But is paying to lower your interest rate worth the expense? Well, it may be if you receive something of greater value in return. That’s the premise behind the concept of paying points.

A point is equal to one percent of your loan amount (i.e., one point on a $200,000 loan equals $2,000) and is an upfront payment to your lender, paid at closing. In exchange for each point paid, you’ll receive a reduction in your interest rate, resulting in a lower monthly payment and less interest paid over the life of the loan.

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As a rule of thumb, the mortgage interest rate is reduced by around a quarter of a percent for every discount point paid. For example, paying four points could lower a mortgage rate by one percent. That’s just a rough guide, though. The actual amount of the discount varies by lender and can fluctuate in response to movements in the bond markets and the direction of interest rates. One day a lender might drop the interest rate by a quarter-point in exchange for the payment of one discount point; the next day, the same rate reduction may cost more or less than it did the day before. Most lenders give buyers the option of paying anywhere from a quarter of a point to upwards of four points and more.

So how can you determine whether paying points is, indeed, advantageous to you? The key is to determine your break-even point.

Have you applied for a mortgage loan lately? If so, you are aware of how much mortgage rates have increased over the past few months.

Step one in making that determination requires that you estimate how long you intend to keep your mortgage. Yes, you may take out a 30-year mortgage, but will you really keep it for the full 30 years?  Probably not. According to a recent survey by the National Association of Realtors, most buyers sell their homes and pay off their mortgages in ten years. For this example, let’s assume that you intend to keep your mortgage for six years.

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