What are Discount Points?

Discount points are an optional prepayment of mortgage interest, paid at closing, that lowers a home buyer’s mortgage rate.

A Longer Definition: Discount Points

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.

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.

Discount Points: A Real World Example

First-Time Home Buyer Stories - Discount Points

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

What is the cost of one discount point?

One discount point typically costs 1 percent of the total mortgage amount, or $1,000 for every $100,000 borrowed or portion thereof.

How much does a discount point lower the interest rate?

The effect of discount points on mortgage rates varies but, generally, the first discount point lowers the interest rate around 0.25 percentage points.

Are discount points tax-deductible?

Yes, discount points are generally tax-deductible, but it’s advisable to consult with a tax professional for specific guidance.

How do origination points differ from discount points?

Origination and discount points are fees paid at closing but serve different purposes. Origination points are a service fee that pays for the lender’s services. Discount points are prepaid interest costs that lower a loan’s interest rate.

What are the benefits of using seller concessions for discount points?

Using seller concessions for discount points can lead to a lower interest rate, reduced monthly mortgage payments, and significant long-term savings on interest. It’s a strategic way to make the most of seller contributions in a real estate transaction.

How do discount points impact a mortgage loan over time?

Over the life of a mortgage loan, discount points can significantly reduce the total amount of interest paid. This impact becomes more pronounced over a longer 30-year loan term, making it a cost-effective strategy for long-term homeowners.

Does purchasing discount points improve my debt-to-income ratio?

Yes, purchasing discount points improves your debt-to-income ratio by lowering your monthly mortgage payments. This can be beneficial for meeting mortgage guideline requirements and improving your overall financial health.

Are there specific situations where buying discount points is highly recommended?

Buying discount points is often recommended for buyers who have excess funds after covering their down payment and closing costs, plan to stay in their home for a long period, and want to reduce their long-term interest expenses.

When are discount points not worth it?

Discount points may not be worth the investment when you plan to move or refinance in the short term, as the upfront cost might not be recouped through interest savings.