Post image for What Are Discount Points and Should You Be Buying Them Or Not?Points, sometimes also called a “discount point”, are a form of pre-paid interest. One point equals one percent of the loan amount. For instance, for a $100,000 loan one discount point equals $1,000.

The reason home buyers buy points is to reduce the interest rate on their mortgage. The rate for your mortgage is usually decided based on your credit score. For borrowers with a less than average credit score this is a method to reduce your monthly costs by reducing the rate.

Each discount point paid on a 30-year loan typically lowers the interest rate by 0.125 percent. That means a 7.5 percent rate would be lowered to 7.375 percent if you purchase one point.

Discount points are tax deductible only for the year in which they were paid.

Points may also be purchased to reduce the monthly payment for the purpose of qualifying for a loan. Loan qualification based on monthly income versus the monthly loan payment may sometimes only be achievable by reducing the monthly payment through the purchasing of points to buy down the interest rate, thereby reducing the monthly loan payment.

How do you decide if you should pay points or not? It depends on how long you plan on staying in the home. You should only buy points if you stay long enough for the savings to start kicking in. Here is how you find this break even point.

For example on a $100,000 Loan – 30 Year Term

7.5% Interest, no points = $699.21 monthly payment

Buying 1 point for $1,000 = monthly payment $690.68

Monthly Savings = $8.53

$1000 / $8.53, = 117 months

Your break-even point is 117 months—or nearly ten years to recover the cost of buying the discount point (considering only the simple calculation of those funds at today’s value).

Selling the property or refinancing prior to this break-even point will result in a net financial loss for the buyer while keeping the loan for longer than this break-even point will result in a net financial savings for the buyer.The longer you keep the property financed under the loan with purchased points, the more the money spent on the points will pay off.

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Because of the many legal and tax situations that can arise through the sale and purchase of real estateALWAYS consult with your ATTORNEY or ACCOUNTANT before making ANY decisions in ANY transaction.

* THIS ARTICLE WAS POSTED AT Thomas Feng’s Bay Area Real Estate Blog *