Mortgage Rates Are 1% Lower Than Pre-Pandemic Levels. You Can Lower Them Further With Discount Points

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The average 30-year fixed rate dropped slightly last week to 3.03%. Despite the modest movement, rates are still much lower than before the pandemic started.
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Mortgage rates have been dropping in recent weeks, getting closer to lows not seen since February. Last week, the average 30-year fixed mortgage rate fell to 3.03%, a modest 0.02% drop from the week prior. 

Although the current rates aren’t quite as low as they were in February, they are still incredibly low compared to this time period two years ago, before the COVID-19 pandemic started. The average 30-year fixed mortgage rate was 3.97% in September 2019, and 3.09% in September 2020. 

A low mortgage interest rate can save prospective homebuyers thousands of dollars in interest, but rising home prices can diminish the benefits. In addition to the current housing shortage, increased demand for homes and increased competition among homebuyers have contributed to rising home prices. The higher the home price, the bigger the loan. And bigger loans need bigger down payments to help offset the monthly costs. So the savings that come with a lower rate can get easily washed out by needing to make a larger down payment to be competitive.

Those who currently own a home, however, can more readily take advantage of these low rates and high home prices by refinancing their existing mortgage or take advantage of existing equity. 

And with refinance rates near all-time lows as well, it may even be a good opportunity to pre-pay interest in the form of discount points to lock in an even lower rate for the long run. Here is how to evaluate discount points. 

ABOUT THE LATEST MORTGAGE RATES

Last week’s average mortgage rate is based on mortgage rate information provided by national lenders to Bankrate.com, which like NextAdvisor is owned by Red Ventures.

What Are Mortgage Discount Points 

Mortgage discount points are fees added to your closing costs that allow you to obtain a lower interest rate on your loan. Discount points are essentially a form of prepaid interest. Instead of paying interest at a higher rate over the duration of your loan, some of that interest is paid upfront. In exchange, lenders will typically offer a lower interest rate.  

One discount point equals 1% of the loan amount. On a $100,000 loan, for example, paying one discount point would add $1,000 to your total closing costs. And on a $200,000 loan, one discount point costs $2,000. Generally speaking, the more discount points you are willing to pay, the lower the rate the lender will offer. 

The chart below is something you might see from a lender that allows borrowers to select a lower interest rate in exchange for paying discount points. Using the NextAdvisor mortgage calculator we calculated the monthly savings associated with buying down the interest rate.   

Table Example: 30-year fixed, $200,000 refinance loan

Points Interest Rate (before Discount) Cost to Buy Down Monthly Principal and Interest Payment Savings Per MonthTotal Interest Paid
Loan A0 Points3%$0$843$103,601
Loan B1/2 Point2.875%$1,000$829$14$98,888
Loan C1 Point2.75%$2,000$816$27$94,029

Are Discount Points for a Refinance Worth It?

Buying down your interest rate with discount points can be beneficial. If you lock in a lower rate for the duration of your loan, you will pay less in total interest in the long-term. In the table example above, the total savings in interest over the life of Loan B is $4,713. In addition to interest saved over the life of the loan, you’ll also get a lower monthly principal and interest payment in exchange for putting a bit more cash in up front.

But if you don’t plan on keeping your mortgage for the long-term, you will want to reconsider because of the break-even point. If you sell your house before hitting that break-even point, you’ll have ended up paying more than you would have if you took the rate without points in the first place.

Using the example from the chart above, for Loan B, buying a 0.125% point rate reduction brings a 3% rate to 2.875%.

The break-even point can be determined by looking at:

  • What the discount points will cost. 
    • Example, Loan B costs $1,000.
  • The amount of monthly savings you would see from a lower interest rate. 
    • Example, Loan B monthly savings is $14.

Using these two figures and this formula, you can then consider whether you’ll sell the house or refinance before you’ve had time to recoup the added costs from paying the discount points. 

Break-even formula: Closing costs / monthly savings = break-even period (in months)

Loan B: $1,000 / $14 = 72 months. 

If you believe you would keep the home loan for at least 72 months, it might be worthwhile to pay discount points on Loan B. In that situation, you’d have enough time to recoup the upfront cost of the discount points and then start to see savings after month 72. 

On the other hand, if you think you might sell before hitting that 6-year point, you’re probably better off sticking with the original rate.