Discount points, often simply called “points,” represent prepaid interest you pay upfront when closing a mortgage to reduce your ongoing interest rate. Each discount point costs 1% of your loan amount—for example, on a $300,000 loan, one point equals $3,000. Paying points lowers your interest rate by a typical range of 0.25% to 0.50% per point, although exact reductions depend on the lender and market conditions. This upfront payment can lead to substantial savings in monthly mortgage payments and total interest paid if you plan to keep the loan for several years.
How Discount Points Work
When you apply for a mortgage, lenders offer you an interest rate based on factors like credit score, loan term, and market rates. Discount points allow you to “buy down” this interest rate by paying part of the lender’s profit margin upfront. This reduces the interest rate and, consequently, your monthly principal and interest payments.
Calculating the Break-Even Point
A key consideration when deciding whether to purchase points is the break-even point—the time it takes for your monthly savings to recoup the initial cost of the points. For instance, if you pay $3,000 for one point and save $50 on your monthly payment, your break-even point is 60 months or 5 years. If you expect to move or refinance before this period, buying points may not be cost-effective.
Example Scenario
Consider a $300,000 mortgage over 30 years:
- Without points, at a 7.0% interest rate, your monthly principal and interest (P&I) payment is approximately $1,996.
- Buying one discount point for $3,000 lowers the rate to 6.75%, reducing your monthly P&I payment to about $1,946.
- Monthly savings of $50 brings your break-even to 60 months.
- Over 30 years, this saves you roughly $18,924 in interest after recouping the initial cost.
This shows paying points is beneficial if you plan to stay in your home longer than the break-even period.
Who Uses Discount Points?
- Homebuyers: Can pay points at purchase to secure a lower rate.
- Refinancing homeowners: May pay points to lower rates on new loans.
- Lenders: Use points as a tool to attract borrowers and increase upfront fee income.
Tips for Using Discount Points Effectively
- Calculate your break-even point before committing.
- Consider your intended homeownership duration; points pay off if you stay past break-even.
- Compare loan estimates from multiple lenders to understand points impact.
- Analyze marginal value—sometimes paying for additional points yields diminishing returns.
- Check with a tax professional about current tax deductibility of points, as laws change.
Common Mistakes to Avoid
- Overlooking break-even calculations.
- Assuming points always save money regardless of plans.
- Confusing discount points with origination points, which are fees for loan processing, not rate reduction.
- Focusing solely on points and ignoring other loan costs.
Frequently Asked Questions
Q: Are discount points the same as origination points?
A: No. Discount points reduce your interest rate. Origination points cover lender fees for processing your loan. Clarify which fees you’re paying.
Q: Can I negotiate points cost?
A: Sometimes, especially with strong credit or competing offers, lenders may negotiate point fees.
Q: Should I pay points if planning to refinance soon?
A: Generally no, because you likely won’t recoup the upfront cost before refinancing.
Q: How much does one point reduce my interest rate?
A: Typically about 0.25% to 0.50% per point, varying by lender.
Additional Resources
Learn more about mortgage points here and tax considerations of points here. For understanding related fees, see our article on Loan Origination Fee.
Authoritative External Link
Consumer Financial Protection Bureau’s guide on discount points provides clear, updated explanations: CFPB Discount Points.
