Points (Discount Points)
Discount points are upfront fees paid to the lender at closing to reduce the mortgage interest rate. Each point equals 1% of the loan amount. Paying points lowers the monthly payment over the life of the loan, making them a form of prepaid interest.
What This Means
How Discount Points Work
One discount point costs 1% of the total loan amount and typically reduces the interest rate by approximately 0.25%, though the exact reduction varies by lender and market conditions. On a $300,000 loan, one point would cost $3,000 at closing. The reduced interest rate applies for the entire loan term, lowering every monthly payment.
Points are distinct from origination fees, which compensate the lender for processing the loan. Some lenders quote origination fees in points, so borrowers should confirm whether quoted points are discount points (which buy down the rate) or origination charges.
Break-Even Analysis
The financial benefit of paying points depends on how long the borrower keeps the loan. To calculate the break-even period, divide the total cost of the points by the monthly payment savings. If one point costs $3,000 and saves $45 per month, the break-even point is approximately 67 months, or about 5.5 years. Borrowers who plan to sell or refinance before reaching the break-even point may not recover the upfront cost.
Tax Considerations and Lender Credits
Discount points paid on a purchase mortgage are generally tax-deductible in the year they are paid. Points on a refinance are typically deducted over the life of the loan. Borrowers should consult a tax professional for guidance specific to their situation.
The opposite of paying points is accepting lender credits, where the lender offers a higher interest rate in exchange for covering some closing costs. This increases the monthly payment but reduces out-of-pocket expenses at closing. The Loan Estimate form itemizes both discount points and lender credits so borrowers can compare options.