Yale Roth M.A., M.Ed

Does It Make Sense To Pay Discount Points On An Adjustable Rate Mortgage?

Paying discount points to get a lower mortgage rate is a question I get from time to time.  Most homeowners and first time home buyers treat discount points or “points” like the plague.

Most homeowners and first time home buyers don’t realize what points are and how they can benefit the borrower.

However, the mortgage question is “Does it make sense to pay discount points to get a lower mortgage rate for an adjustable rate mortgage?”

Before I answer the mortgage question, I want to define what discount points are and why some homeowners or first time home buyers will pay them.

Discount points represent 1% of the loan amount and are used to buy the mortgage rate down.

Discount points – not origination points – are prepaid mortgage interest that  the homeowner or first time home buyer is paying upfront at closing to get a lower mortgage rate knowing that over time the homeowner or first time home buyer will save movey with the  lower mortgage rate.

Paying discount points can be useful and can save the homeowner or first time home buyer money over time.  Time is the critical factor here because the homeowner or first time home buyer has to keep the mortgage long enough to recover the upfront costs (or points.)

That’s why it DOESN’T make sense to pay discount points to get a lower mortgage rate if you’re in a an adjustable rate mortgage, also known as a ARM.

The reason is because the mortgage rate in the adjustable rate mortgage is fixed for a certain amount of time, then adjusts.

So the problem is that the mortgage rate can change or adjust before the homeowner or first time homebuyer recovers their upfront points.

In conclusion, homewoners and first time home buyers – it doesn’t make sense to pay discount points to get a lower mortgage ratre if you’re applying for an adjustable rate mortgage.

You have to do the math to calculate the recovery period, but in all liklihood – you will not have enough time to recover your upfront discount points  before the mortgage rate adajusts.

The way to calculate this is to compare the mortgage payment for two different mortgage rates.

Take the difference in mortgage payment and divide it into the difference in lender fees – with discount points and without discount points.  This will tell the homeowner or first time home buyer how long it’ll take to recoup the upfront discount points.

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