Who doesn't want to lower their mortgage interest rates? Most of my clients mention current interest rates as a serious barrier to refinancing or purchasing a home. They may have purchased or refinanced in 2021, and as of this writing interest rates are not going back down to 2.9% in the near future. That doesn't mean all buyers have to resign themselves to paying 6% on a thirty-year mortgage.

This blog post is intended to educate clients and members of the public on the basic features of mortgage discount points. If it isn't covered in this post, or another one of my related blog posts, you'll need to talk to a mortgage lender, and I'd be happy to make a competent referral: use the contact form below to set up an appointment with me.

A quick definition of discount points before we get started: discount points can be purchased as prepaid mortgage loan interest to incrementally lower your interest rate for the life of your mortgage loan.

How Mortgage Discount Points Work

As stated above, discount points are an up-front fee you pay to reduce the interest rate on a mortgage. Every discount point you purchase buys down the loan's interest rate by 0.25%. For instance, purchasing one discount point on a mortgage loan with a 6.5% interest rate will lower the interest rate to 6.25% for the life of the mortgage loan. The more points you buy, the lower your interest rate will be. This can represent a massive interest savings over the course of a thirty-year mortgage loan.  

The Cost of Discount Points

A single discount point will cost 1% of the entire mortgage loan. For instance, a single discount point on a $200,000 mortgage loan will cost $2,000. Most home buyers purchase between one and three points; most mortgage lenders cap the number of discount points a homebuyer can purchase at closing at four discount points, giving buyers a maximum 1% rate discount on their mortgage over the life of the loan. Some mortgage lenders allow buyers to buy fractional discount points, giving both parties more room to negotiate.

Benefits of Purchasing Discount Points

Purchasing discount points to obtain a lower interest rate on your mortgage loan can give you many benefits:

1. You will pay less interest over the life of the loan: if you're reading this blog post, chances are good that you've already calculated the principal and interest payments that work with your current budget. I often use Mortgage Calculator to help determine how much a 0.25% change in interest rate might save myself or a client. 
2. Your monthly payment will be lower: many buyers avoid discount points because they can deplete valuable cash reserves, however, I advise my clients to run the math for themselves to determine what will work best for them. Often, the lower monthly payment on the mortgage will allow the homebuyer to regenerate those cash reserves faster; in those cases, having purchased discount points saves the homebuyer a lot of money in the long run.
3. Discount points may constitute tax-deductible mortgage interest: Unlike mortgage origination fees, discount points are actually interest payments. Talk to your CPA about whether it works with your tax strategy to itemize and deduct your discount point purchase.

Disadvantages of Purchasing Discount Points

1. Discount points stretch most homebuyers' budgets: Given the high cost of homes, spending thousands of dollars in addition to earnest money, the cost of inspection, potentially negotiated costs to close, and the actual down payment is not within many home buyers' budgets. Even the experienced real estate investors I work with tend to have other more urgent uses for their cash reserves.
2. Breaking even on your discount points will take several years: You can decrease your monthly mortgage payments. The cost of your discount points divided by your monthly savings on your mortgage payments
   cost of points divided by monthly savings = number of months to break even
3. Buying discount points before interest rates decrease: If interest rates decrease before you have reached your discount points break-even point, you may lose out on the opportunity to refinance your mortgage at that lower interest rate without having to purchase discount points.
4. The opportunity cost of purchasing discount points: You should run the numbers or talk to your financial advisor about whether the money you spend on discount points could be saved or invested and give you a greater return on your investment than the long-term savings on interest. 

Work With a Knowledgeable Realtor on Your Next Alaska Home Purchase

Being able to talk to my clients about these considerations is an exciting part of working with homebuyers, whether they're first-time homebuyers or experienced real estate investors. In my work as an estate planning attorney and as a realtor, I am constantly engaging with continuing education. The two practices enrich each other, and although I am not a CPA or financial advisor, I am able to have educated discussions with my clients about their real estate investment strategies as a result of both experiences. To schedule one of those conversations, contact me to get a link to my Calendly.