Discount points

Also called mortgage points, buying down the rate

Upfront fees paid to a lender at closing to lower a mortgage’s interest rate, with one point equal to 1% of the loan amount.

What it means

Paying discount points is prepaying interest in exchange for a lower rate for the life of a fixed loan. One point costs 1% of the loan amount; how much each point lowers the rate varies by lender and market conditions.

Whether points pay off depends on how long the borrower keeps the loan. The break-even point is the upfront cost divided by the monthly savings. Selling or refinancing before then means the points cost more than they saved. Points may be tax deductible in some situations; the rules depend on the loan and the borrower’s tax return.

Formula

Break-even months = cost of points ÷ monthly payment savings

cost of points = points × 1% × loan amount
monthly payment savings = old payment − new payment

Example

Suppose one point on a $300,000 30-year loan costs $3,000 and lowers the rate from an illustrative 6.5% to 6.25%. The payment falls from about $1,896.20 to $1,847.15, saving about $49.05 a month, so break-even takes about 61 months.

How it’s used

Lowering the rate on a home expected to be kept many years
Comparing loan offers with different fees
Using seller concessions at closing

Strengths and weaknesses

Strengths

Lower rate and payment for the life of a fixed loan
Large savings over a long holding period
Sometimes partly tax deductible

Weaknesses

Requires extra cash at closing
Lost money if the loan is paid off before break-even
Cash might be better used for a larger down payment or reserves

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.