If you plan on purchasing a house in the Greater Boston Area, and plan on living in the house/owning the house for a long period of time (10 years or greater), then it might be in your best financial interest to purchase mortgage discount points from your mortgage lender. While the initial investment is a bit high, in the long run it will pay off big dividends.
What Are Mortgage Discount Points? A mortgage discount point is a type of prepaid interest which allows you to lower your actual monthly mortgage payments. That is, for every discount coupon you purchase and use, the amount of interest which you actually pay on the loan is reduced by a small percentage.
Discount coupons usually cost 1% of the total loan amount which is borrowed. Every discount point which you use can result in a reduction of 0.125% to 0.25% from your total interest rate, but the exact discount percentage varies according to lender and according to fluctuations in the bond market. For instance, a a 0.25% reduction may cost an entire point today, the next day it might cost just half a point for the same reduction.
Pros of Mortgage Discount Points
- Pays Off In The Long Term: While the reduction is interest rates might seem to be extremely small, the savings will add up and pay huge dividends in the future. Simply put, the longer you keep the mortgage loan, the more money you save.
- There’s always some sort of discount: While the discount amount actually varies, there is always some amount of discount every time you purchase discount points.
Cons of Mortgage Discount Points
- High Initial Investment: Since every point costs 1% of the total loan amount, purchasing mortgage loan points can be a big financial burden in the beginning.
- Amount Of Discount Varies: While you will definitely get some discount from your monthly interest rate, the exact amount varies.
- Break Even Point Takes Time: To break even i.e. to recover the amount you initially paid to purchase the discount points, from your monthly savings alone will take anywhere between five to ten years.
Calculating the Break Even Point Finding out how many years it will take you to break even is pretty simple:
- Take a clean sheet of paper, write down the total amount you are borrowing on the top, and divide the sheet below into two sides.
- On one side of the sheet write down the amount of monthly interest you will have to pay on it without any discount.
- In the other side, write down the amount of monthly interest you will pay after claiming the discount point.
- Subtract the two numbers you get from step 2 and 3 to figure out your real savings for a month.
- Divide the total amount you paid for the discount coupon by your real monthly savings.
The number which you get at the end of step 5 is the number of months you need to hold on to the mortgage for you to break even. If you plan on holding the mortgage for that period of time, then a mortgage loan discount coupon would be a good idea to invest in.