With rates in a free fall, can ARM mortgages save you money down the road?
What is a discount point?
A discount point is a sum of money paid by the borrower or home buyer to the lender of the mortgage to decrease the interest rate of a mortgage.
Discount points help home buyers to reduce their monthly mortgage payments and interest rates. A discount point is most often paid before the start of the loan period, usually during the closing process. It is a type of prepaid interest made on the loan.
The cost of a point depends on the value of the borrowed money, but it is generally 1 percent of the total amount borrowed to buy the home.
Paying discount points helps to reduce the overall cost of the loan. Generally, each point will reduce the mortgage loan’s interest rate by one-eighth of a percent, and up to one-quarter of a percent. Factored over the length of the loan itself, this can substantially reduce how much interest the home buyer pays for the home.
Discount points are also tax deductible, but only for the year in which they were paid.
In some situations, it is possible to roll discount points and other closing costs into the loan balance. Doing this eliminates the need for the home buyer to pay this cost out of pocket.
Discount points example
Matthew decides to purchase a home and needs to borrow $300,000 to do so. The mortgage is for 30 years. He decides to pay two discount points. Matthew pays $6,000 upfront (two times 1 percent of the borrowed funds). This reduces his interest rate from 4.5 percent to 4 percent. Over the course of the loan, it also reduces his monthly mortgage payment from $1,490 to $1,432.
Making the decision whether or not to use discount points can be difficult. Using our mortgage points calculator, the situation becomes clear.