Should You Lower Your Mortgage Rate With Discount Points?

When buying a home today, you might have to solve a puzzle about the mortgage rate you'll pay. Which would you do?

• Get the lowest monthly payment now by paying discount points to reduce the interest rate.

• Make monthly payments at today's interest rate and wait an unknowable time for rates to fall so you can refinance, at which time you'll pay closing costs of roughly 2% to 6% of the loan amount.

A one-size-fits-all answer doesn't exist, but it might be wise to lean toward paying discount points these days. Here's how to make a decision that fits your circumstances.

What are discount points?

Discount points are a fee paid to the lender to reduce the mortgage's interest rate. One discount point equals 1% of the loan amount and typically reduces the interest rate by around a quarter of a percentage point. The rate reduction lasts for the life of the loan, and it's sometimes called a "permanent buydown."

Here's an illustration you can try with a mortgage points calculator:

A buyer getting a $300,000 mortgage could pay $3,000 for one discount point to cut the mortgage rate from 7% to 6.75%. The monthly payment would shrink by $50. The accumulated monthly savings would exceed the upfront cost after 60 months for a five-year break-even period. Over those five years, you'd save $774 on interest (including the $3,000 in points, which are prepaid interest) and build up $768 more equity.

Discount points have become commonplace since mortgage rates jumped last spring. More than half of borrowers have paid discount points since then, according to data analytics company Black Knight.

As lenders compete for business, discount points may yield more bang for the buck. Nowadays, it's not unusual for one point to reduce the rate by more than half a percentage point instead of the usual quarter of a percentage point, says Jim Sahnger, mortgage originator for C2 Financial Corp., in Jupiter, Florida. That shortens the break-even period.

When shopping mortgage offers, be aware that some of your rates may already include discount points. Make sure to find out the interest rate without discount points as well. That way, you can easily compare the impact of paying discount points with a no-points loan.

The customary way of thinking about it

The standard advice is to consider how long you intend to own the house.

"If the home buyer plans to move out of the home within a few years, it may be more beneficial to take on the higher rate," instead of paying discount points, said Dan Hanson, loanDepot executive director of in-market retail, in an email.

But if you plan to own your place past the break-even period, you'll save by paying discount points.