discount points faq

Discount points are fees paid to a lender at closing in order to lower your mortgage interest rate. While buying points is sometimes a good decision, many times the purchase costs you more than it saves. The cost of each point is equal to one percent of the loan amount. For instance, for a $100,000 loan one discount point equals $1,000. Each discount point paid on a 30-year loan typically lowers the interest rate by 0.125 percent. That means a 7.5 percent rate would be lowered to 7.375 percent if you purchase one point. Paying for points lowers your interest rate, because the lender receives the income in a lump sum at closing rather than collecting the interest as you make payments on your loan. 

Buying Points to Lower Your Interest Rate, It’s Not Always a Good Idea

Discount points are fees paid to a lender at closing in order to lower your mortgage interest rate. While buying points is sometimes a good decision, many times the purchase costs you more than it saves.

How Much Do Points Cost?

The cost of each point is equal to one percent of the loan amount. For instance, for a $100,000 loan one discount point equals $1,000.

How Much Does Buying a Point Lower Interest?

Each discount point paid on a 30-year loan typically lowers the interest rate by 0.250 percent. That means a 5.5 percent rate would be lowered to 5.250 percent if you purchase one point.

Paying for points lowers your interest rate, because the lender receives the income in a lump sum at closing rather than collecting the interest as you make payments on your loan.

Should I Buy Points?

Whether or not paying points makes sense for you depends in part on how long you plan to keep the loan. Use a mortgage calculator to help you decide.

  • Calculate the amount of your monthly payment at the interest rate you will be charged if you do not pay points.
  • Calculate the amount of your monthly payment at the lower rate if you do pay points.
  • Deduct the lower payment from the higher payment to find the amount saved each month.
  • Divide the amount charged for points at closing by the monthly amount saved. The result is the number of months you must keep the loan to break-even on paying points.

Break Even Example – $100,000 Loan – 30 Year Term

  • 5.5% Interest, no points = $567.79 monthly payment
  • Buying 1 point for $1,000 = monthly payment $552.20
  • Monthly Savings = $15.58
  • $1000 / $15.58, = 64 months

Your break-even point is 64 months-or over 5 years to recover the cost of buying the discount point (considering only the simple calculation of those funds at today’s value).

Do you plan to stay in the house that long? If not, buying points might not make sense.

Slightly Lower Principal Balance

If you were to look at amortization schedules to compare the two loans, you’ll see that the lower interest loan does have a slightly lower principal balance at the end of 64 months. This is one additional reason to pay points to get the lowest rate possible, but only if you plan to live in the home long enough to reap the rewards.

Can the seller pay for my discount points?

Probably. Talk with your lender about what’s allowed with your loan. A motivated seller will sometimes agree to pay some of your closing costs in order to facilitate a quick transaction. A mortgage lender who works closely with your real estate agent is the best way to facilitate this discussion in your favor.

Are discount points tax deductible?

Yes, points paid for the purchase of residential real estate are tax deductible in the year they are paid. Buyers may deduct the amount paid even if the seller pays for the points at closing.

Are discount points the same as an origination fee?

An origination fee is a fee charged to originate and process your loan. It typically costs the same as one point, but it is a different type of fee. Ask each loan officer or mortgage broker you talk with if you will be charged an origination fee in addition to discount points. Many loan officers will use a term like, “this loan will cost you 2 points” when in fact, there may be a 1% loan origination fee and a 1% loan discount points fee.