JMAC’s brokers are often asked about discount points; whether to pay or not to pay is a question you should discuss with your borrowers. This one-time, upfront closing cost will "discount" the available mortgage rate and thus gain access to lower interest rates. It is also referred to as “buying down the rate.” Discount points, however, have to be paid in full at the closing of the loan, and this rate buy down is not cheap.
There are situations in which paying for discount points is beneficial, especially when the seller is paying closing costs. Our brokers see numerous situations where the real estate agent may be able to negotiate closing costs into the home purchase contract via seller concessions. Paying one point will typically reduce an interest rate by 0.25 percent. The cost of one point is equal to 1% of the loan amount. For example, if the quoted interest rate on a $200,000 purchase is listed at 4%, paying one discount point will cost $1,000 and can lower the interest rate to 3.75 percent.
Discount points can also be tax deductible, depending on which deductions can be claimed on individual federal income taxes. Discount points paid in conjunction with a home purchase can be 100% deductible in the year in which they're paid. Experienced brokers will remind their clients to always check with an accountant for verification.
However, just because a borrower is in a financial position to pay points doesn't necessarily mean they should. Since points are paid upfront in addition to closing costs (closing costs for each state vary as well), the additional fee should be weighed against the overall long-term savings of the mortgage loan.
Paying a fee to lower a mortgage rate might result in huge long-term savings on a 30-year loan, but a borrower planning to move or refinance within a few years will likely never recoup the initial investment. Consideration of financial benefits and detriments should be plotted and discussed thoroughly by the broker with a borrower before choosing the path of buying down the rate.