Refinancing your mortgage can save you money, and paying extra for discount points could save you even more. Points are a form of prepaid interest: you pay extra at the time you refinance and the bank rewards you with a lower interest rate. However, paying points isn't for everyone.
Lower Interest Rate
Points are most beneficial when you keep the loan for a long time. If you've got a house that you expect to live in for many years to come, maybe even start a family in, points could be a good longer-term investment because they will save you money over the life of the mortgage. Not only will your monthly payment be lower, but you will also pay less in interest over the term of the loan.
Extra Tax Breaks
The amount that you pay for the discount points on your refinance is deductible on your income taxes. However, you have to amortize the points over the life of the refinance. For example, if you pay $2,700 in points and your refinance term is 20 years, you can deduct $135 each year. Never fear: if you move or refinance before you use the entire deduction, you can take any remaining points in the last year.
Not Good for Short Terms
If you plan on moving out or moving up to another home within the next few years, you'll likely not enjoy the lower monthly payments long enough to recoup the costs of the points. For example, if you plan to move in a few years, you lose the benefit because you can't carry over the points to your new mortgage. If you aren't sure whether you should pay for points, divide the cost of the points by your monthly savings to figure out about how long it would take to recover your costs. For example, if you pay $5,000 in points and it saves you $100 per month, it would take you 50 months before you recovered your costs.
Costs Due at Closing
When you want discount points, you have to pay the extra cost at closing. If you've been sitting on cash, it's not a problem. However, if you're refinancing because you're struggling to make your mortgage payment, you're probably hurting for cash. Or, if you're carrying balances on your high-interest credit cards, you're likely going to save more by paying down those balances rather than trying to get a slightly lower rate on your home interest rate.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."