A very common question I get from clients is, “What are points? Do I need or want them?”
“Points” is actually short for discount points. The funny thing is, if you look on dictionary.com, they don’t have a definition for the term! What it boils down to is this: discount points are a type of prepaid (upfront) interest that mortgage borrowers can pay to potentially lower the amount of interest they will have to pay on subsequent payments. This is made possible by accessing a “discounted” interest rate. Each discount point generally costs one percent of the total loan amount and, generally, each point lowers your interest rate by one-eighth to one-quarter of a percent. At the moment, discount points are tax deductible only for the year in which they were paid. Consult with your tax advisor regarding your personal tax deductibility.
So, do you need “points” for your mortgage? Generally, for it to make sense to invest in the points, you will need to be at least fairly certain that you will remain in the new home and retain the original mortgage for at least five years. If my clients wish to consider points, we typically run a “what if ” to see how long it would take to recoup the hard cost of points paid based on the monthly payment savings. In other words, how many payments made at the lower rate will it take to recover the cost of the points? I can do this simple calculation for my clients and together we usually make the easy decision of paying points or not.
So, that’s the whole idea! Pretty simple once you know the basics. Or, should I say… I’m sure you get the point!