As the housing market became less affordable, more and more buyers opted for a strategy for reduce your mortgage rate: acquire “discount points”” o “rate purchase”.
This involves carrying out a additional payment to lender at the time of closing, in order to reduce the interest rate on the loan. This adjustment allows you to obtain lower monthly payments and generate interest savings throughout the life of the mortgage.
Typically, paying an amount equal to 1% of the total loan amount (called one point) allows reduce the interest rate by approximately 0.25%.
With the increase in rates, which began to be reduced in 2024, this practice gained popularity: last year, 49% of buyers chose to purchase points, almost double the 27% registered in 2019, according to the latest data of Zillow.
With the increase in rates, this practice gained popularity: in 2023, 49% of buyers chose to purchase points, almost double the 27% registered in 2019 (Archive)Freepik
“The purchase of points is currently in high demand, since many borrowers are looking for lower ratessimilar to those recorded during the pandemic,” said Aaron Gordon, manager of Guild Mortgage to CNBC. However, he emphasizes that it is a “personal” decision, since what is advantageous for one borrower is not necessarily advantageous for another.
Buying points is usually more beneficial for those who plan to stay in the home for the long term. long termsince it can take between five and seven years Break even and recover your initial investment in reduced monthly payments.
An immediate advantage is that The cost of the points is tax deductible as prepaid mortgage interestas long as it concerns the main residence and is detailed in the deductions.
However, for certain buyers, putting that extra money towards a larger down payment could be more advantageous than purchasing points. A larger down payment reduces the total loan amount, which, in turn, lowers your monthly payments. In addition, contributing at least 20% of the total value helps avoid private mortgage insurance (PMI)which can add more than $100 a month on a $300,000 loan, although it varies depending on the credit rating and the size of the down payment.
Ultimately, whether it is most convenient to increase the initial payment or acquire points will depend on the specific conditions of each loan.
Another alternative could be wait for the market to stabilize. Although purchasing points reduces the interest rate, the initial cost is not profitable if you plan to refinance before reaching the break-even point, since refinancing involves expenses ranging between 2% and 6% of the loan amount, according LendingTree.
Forecasts indicate that mortgage rates could fall from around 6.1% to approximately 5.5% by 2025. In this context, wait for rates go down or refinancing at that time could be a cheaper option to get a low rate without paying points up front, thus avoiding duplicate costs.
Another option is to consider a temporary reduction of the interest rate, which implies a reduction of 1 to 3 percentage points, but only during the first years of the mortgage. These temporary reductions are usually cheaper than acquire discount points for a permanent decrease in the rate, making it easier to reach the break-even point in two or three years.
What is the 2-1 rule
The most common temporary reduction is type 2-1, which reduces the rate by 2 percentage points during the first year, 1 point in the secondand in the third year it returns to the full rate for the remainder of the loan term. The cost of this agreement is usually between 1% and 2% of the loan amount.
Another option is to consider a temporary reduction in the interest rate, which implies a reduction of 1 to 3 percentage points, but only during the first years of the mortgage (File)
“I have had several clients who have chosen to reduce their short-term rates using programs such as 3-2-1 reduction,” says Robert Washington, broker. Savvy Buyers Realty, to the same medium. “The idea is to refinance once rates go down again at 5% or 6% range”.
Regardless of the option chosen—buy points, apply a temporary reduction, or increase the down payment—it is advisable to consult with a mortgage advisor to evaluate which is the best alternative according to the financial situation of each person. Reduction programs and loan terms vary, so professional advice can ensure that the most convenient decision is being made, they conclude.
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