Key Takeaways
- Discount points lower your interest rate, potentially saving money over time.
- Each point costs 1% of the total loan amount.
- Consider points if you plan to stay in the home 5+ years.
- Calculate if savings outweigh upfront costs before purchasing points.
Article Summary
Discount points are an optional prepayment of mortgage interest, paid at closing, that lowers a home buyer's mortgage rate.
Discount Points: Explained in Plain English
Discount points, often called "points," are a form of prepaid interest that borrowers can pay to reduce their mortgage's interest rate. One discount point costs 1 percent of the mortgage amount.
Historically, a home buyer can pay one discount point to lower their mortgage rate by 25 basis points. The precise discount varies based on prevailing mortgage market conditions. Buyers may purchase multiple discount points and receive larger mortgage rate discounts.
Paying for discount points is an upfront payment in exchange for a reduced mortgage rate over the life of the loan. Home buyers should calculate whether the upfront cost of buying points is outweighed by their long-term interest savings, which depends on the reduction in interest rate and the length of time the borrower plans to hold the mortgage.
Average Discount Points Paid by Home Buyers
| Loan Type | Average Discount Points Paid |
|---|---|
| Conventional | 0.900% |
| FHA | 1.072% |
| VA | 0.917% |
| USDA | 0.879% |
When To Pay Discount Points
There are five general scenarios when it makes sense for buyers to pay discount points on their mortgage.
The mortgage qualification reason to pay points
For home buyers who don't qualify for a mortgage at today's mortgage rates because their debt-to-income (DTI) is too high, paying discount points is a good strategy for getting access to lower mortgage rates, which, in turn, lowers the DTI.
Home buyers can reduce their debt-to-income ratio by paying mortgage discount points.
The budget reason to pay points
For home buyers prioritizing a lower monthly mortgage payment and with sufficient cash reserves, paying for discount points can be a strategic financial decision. By buying discount points, these buyers can secure a lower interest rate on their mortgage, which yields smaller monthly payments.
Paying for points is especially appealing for home buyers who budgeted carefully for their home purchase and have excess cash beyond their down payment and closing costs.
The long-term residency reason to pay points
For home buyers who plan to stay in their current home and will not refinance for at least five years, purchasing discount points can be a long-term money-saver. Their long-term commitment to the home and its original mortgage allows ample time for the monthly savings to surpass the upfront expense.
This strategy is especially helpful for home buyers with a forgivable mortgage.
The purchase sales contract reason to pay points
For home buyers receiving seller concessions from the seller, using cash to buy discount points is a savvy way to lower the mortgage rate and make the home less expensive. Reducing the mortgage rate does more to affect home affordability than reducing the sales prices.
Ask your buyer's agent to add seller concessions to your purchase contract.
The mortgage market reason to pay points
During periods of market instability, home buyers may find that every mortgage loan requires discount points. When this happens, buyers should plan to pay discount points as part of their purchase or negotiate for seller concessions.
When Paying Discount Points Makes Sense
| Situation | Why Pay Points |
|---|---|
| Need to qualify for a loan | Lower your DTI |
| Want a lower monthly payment | Reduce payment amount |
| Plan to keep the home long-term | Save more over time |
| Seller is covering closing costs | Use seller money for points |
| All lenders require points | It's a market standard |
Discount Points: A Real World Example
Imagine a first-time home buyer who negotiates a purchase contract with 3 percent in seller concessions. Then, as the buyer is making their mortgage rate lock, they find that their seller concessions exceed their total closing costs.
Seeing an opportunity to maximize seller contributions, the buyer uses the leftover concessions to purchase mortgage discount points and get a lower mortgage rate. The reduction decreases their monthly mortgage payment, lowers their debt-to-income ratio, and creates significant interest savings over the 30-year life of the loan.
Common Questions About Discount Points
Frequently asked questions about discount points and how they work to lower mortgage rates.
