By Peter McDougall

You can lower your mortgage rate by paying your lender for ‘points,’ but you could also just increase the amount of your down payment. BankingMyWay offers tools to help you decide the best option.

Most homebuyers would jump at the chance to secure a lower rate on their mortgage. And many do by paying their lender a fixed amount -- called a “point” -- for every fraction of a percentage point shaved their loan’s interest rate. But while a lower mortgage rate is attractive, buying points isn’t always worth the cost.

Money spent on points can instead go toward a larger down payment. Both approaches will lower your monthly payments, but it takes longer for the benefits of paying points to outweigh the benefits of a larger down payment.

To get an idea of which option is best for your situation, take a look at BankingMyWay.com's Mortgage Point calculator.

Crunch the Numbers

A mortgage point equals 1% of your loan and generally involves a 0.125% reduction in your interest rate, per point -- although the rate cut will vary from lender to lender. The calculator compares how much you’d save by paying for points with what you'd save by increasing your down payment.

To find out which choice is likely best for your situation, enter your loan amount, the term and the interest rates -- with and without points -- into the calculator. Also include the number of years you expect to live in your home.

Despite the lower monthly payments, increasing the down payment is the better choice in this instance unless you plan to live in your home for longer than 14 years. The reason? The bigger down payment helps to build equity faster so that you own more of your home when it comes time to sell. Only after 14 years will the interest savings from the lower rate surpass the increased equity from the larger down payment.   

Shop Around

Not all lenders will offer just a 0.125% rate cut per point -- the bigger the rate cut per point, the less time it will take for the interest savings to surpass the savings from a bigger down payment. Consider asking the various lenders how much each mortgage point (also called a discount point) will lower the overall interest rate, and factoring that into your decision.

For instance, in the New York metropolitan area, Webster Bank (WBS) and Capital One (COF) offer the same interest rate of 5.25% on their 30-year, fixed-rate mortgages, but one might offer a larger rate cut per point than the other.

Consider using the calculator to compare different loan offers with different points. Wachovia Bank (WB) currently offers a 4.875% rate with 0.5 points, whereas HSBC (HBC) offers a 5% rate without points. Without taking into consideration the impact of closing costs on the cost of the loan, paying the points on the Wachovia offer is the better option if you plan on living in your home for five years or more.

Peter McDougall is a freelance writer who lives in Freeport, Maine, with his wife and their dog.

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