People Are Using Mortgage Points to Lower Their Rates—Are They Worth It?

While most people—especially home buyers—are aware of the steady climb of mortgage rates from below 3% in 2021 to a recent high of approximately 7%, they may not realize that a the same time there has been a jump in borrowers paying to lower their rates.A recent analysis by Zillow Home Loans found that nearly 45% of borrowers purchased mortgage points, also known as discount points, in 2022 to reduce their monthly payments. That compares to 29% of borrowers who bought mortgage points in 2021, 28% in 2020 and 27% in 2019.“We started seeing more buyers purchasing discount points as soon as mortgage rates ticked up in 2022,” says Nicole Bachaud, senior economist for Zillow in Seattle. “We don’t have data for 2023 yet, but since rates are relatively high compared with the last couple of years, we’re likely to see just as high or even a higher share of borrowers paying for points this year.”How mortgage points workA borrower can purchase mortgage points, which each cost 1% of the loan balance, to lower the interest rate on their mortgage. The amount of the discount varies from one loan and lender to another, but generally one point lowers your rate by 0.25%.For example, a discount point on a $400,000 loan would cost $4,000 and could lower your rate from 6.5% to 6.25%, saving approximately $65 a month.Essentially, a discount point is prepaid interest on your loan, but some borrowers confuse them with origination points, says Chuck Cavanaugh, head of financial planning and annuity distribution at Citibank in New York City.“An origination point is a fee charged by the lender to handle your loan, while discount points are optional for borrowers,” Cavanaugh says.Why discount points are popular when rates are risingA discount point reduces the mortgage rate over the life of the loan, so people pay points to make their payments more affordable. The combination of high home prices and high mortgage rates contributes to the current appeal of paying discount points.“When rates are lower, borrowers are less concerned about buying down the rate by a quarter percent because it’s already low,” says Bachaud. When rates are high, however, borrowers look for any possible way to reduce their monthly payments.Psychology may also play a role, says Mike Salierno, a financial advisor with Northwestern Mutual, a financial services company in Clearwater, Fla. “Sometimes people just want to be able to say they have a mortgage rate under a certain threshold or one that’s better than their neighbor’s.”An important step to decide if purchasing discount points makes sense for you is calculating the break-even point, which is when your monthly savings exceed the amount of cash you paid for the point. For example, on the $400,000 loan example above, the break-even point would be about five years and two months ($4,000 divided by $65 equals about 62 months). So in this case, it would only be worth paying for points if you stayed in the house for at least five years or six years.“It all comes down to how long you’ll be in the house or whether you think you might refinance before the break-even point,” Salierno says.Who buys mortgage pointsWhile every buyer wants the lowest possible rate, not everyone can spend the cash to buy down their rate. Zillow’s research found that buyers who purchased the most discount points bought homes in the middle and top price tiers in their market.Cavanaugh has noted the same pattern. “Even a small reduction in the mortgage rate can have a big impact on a larger loan.”Conversely, when broken out by income level, Zillow’s analysis found that paying points is most common among borrowers who earn between 30% and 50% of their area’s median income. This is likely because these borrowers are the most concerned about affording their monthly payments. In some cases, these borrowers are eligible for down payment assistance and first-time buyer programs with lower closing costs, so they can use their savings to buy down their mortgage rate instead of for other initial expenses. “It’s a different way to hack into homeownership for some buyers,” Bachaud says.Cash-out refinance borrowers were also more likely than other borrowers to buy mortgage points. “When homeowners do a cash-out refinance, they have a sense of being flush with cash, so they’re more comfortable paying a discount point or two to get a lower mortgage rate,” Bachaud says. “And since they’re refinancing, they clearly plan to stay in the house for a long time.”Bigger down payment or discount point?If you have cash saved for a home purchase, you may be considering adding to your down payment rather than buying down your mortgage rate. If you have enough cash to make a down payment of 20%, that will have a bigger impact on your payments than buying down your rate because 20% allows you to avoid paying for private mortgage insurance, Cavanaugh says.Beyond the 20% threshold, you’ll often get a better return buying a discount point than adding to your down payment, but Cavanaugh says it is important to run the numbers.For example, if you have a $400,000 loan balance and pay an extra $4,000 in down payment, your monthly payment at a 6.5% rate would drop by $28 a month compared with saving $65 if you opted to buy a discount point for that amount.“You really need to analyze every scenario with a lender because you may be offered a lower mortgage rate if you make a bigger down payment,” Bachaud says.A bigger priority than a small reduction in your mortgage rate should be having a solid emergency fund and to pay off credit card debt that carries a high interest rate, advises Cavanaugh. If you have extra cash when you’re buying or refinancing, consult your lender and financial advisor to decide the best way to use it.MORE ON MORTGAGESThe advice, recommendations or rankings expressed in this article are those of the Buy Side from WSJ editorial team, and have not been reviewed or endorsed by our commercial partners.

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