Rising Mortgage Rates Lead to Surge in Discount Point Purchases

As mortgage rates surged to 23-year highs in 2023, many homebuyers opted to pay extra discount points in an attempt to lower their mortgage rates. However, recent data suggests that this strategy may not have been as beneficial as anticipated.

Freddie Mac reported that over half of US borrowers paid discount points in 2023, a significant increase from previous years. Discount points, also known as rate buydowns, are upfront fees paid at closing to reduce the mortgage interest rate.

Despite the increase in buyers purchasing points, Freddie Mac found that the difference in interest rates between those who did and did not pay points was minimal. For purchase borrowers, the average rate for those paying discount points was 6.61%, compared to 6.69% for those who did not.

This trend was particularly notable among borrowers refinancing their mortgages, with over 82% of cash-out refinancers and nearly 60% of non-cash-out refinancers choosing to buy down their rate.

The surge in discount point purchases reflects the financial strain felt by many borrowers as rates climbed towards 7%. With rates reaching historically high levels, borrowers sought ways to mitigate costs, including through incentives like rate buydowns.

However, experts caution that purchasing discount points may not always be a wise financial decision. While paying points upfront can lead to a lower long-term interest rate and reduced monthly payments, the upfront cost may not be recouped for many years.

For instance, on a $400,000 loan, purchasing one point would cost $4,000 at closing and typically reduce the interest rate by 0.125% to 0.25%. While this may result in modest monthly savings, it could take several years to offset the upfront cost.

Ultimately, the decision to purchase discount points depends on individual circumstances and long-term financial goals. While some borrowers may benefit from lower monthly payments over time, others may find that the upfront cost outweighs the potential savings.

As mortgage rates gradually decline from their 2023 highs, some housing experts advise against indulging in discount point purchases, especially if the breakeven period extends beyond a few years. However, the choice ultimately rests with the borrower, who should carefully consider their options and consult with a financial advisor if needed.