5 things to know about mortgage discount points and how they work:
- Discount points are fees that some borrowers pay up front in order to lower their mortgage rates for the entire loan term.
- Each point costs 1% of the base loan amount and typically reduces the mortgage rate by around 0.25% (but this can vary).
- With this strategy, you’re paying more money at closing in order to reduce your interest costs over the long term.
- Paying mortgage points is optional. Whether or not it makes sense largely depends on how long you plan to keep the mortgage.
- If you pay for discount points but only keep the loan for a few years, you probably won’t recoup your investment.
That’s the short version. Keep reading below for a more detailed explanation of how it all works, along with some example scenarios.
What Is a Mortgage Discount Point?
Mortgage points (also referred to as discount points) are fees a borrower pays to a lender in order to secure a reduced interest rate on a home loan. These fees are typically paid at closing and count toward the borrower’s overall closing costs.
One point equals 1% of the base loan amount and typically reduces the interest rate by 0.25%. So in this case, a borrower could lower their mortgage rate by around 0.25% for each discount point they buy.
This strategy is also referred to as “buying down” the interest rate, because you are buying a reduction in your mortgage rate in order to save money over time.
Here’s how the process typically works:
- The borrower chooses a lender and applies for a mortgage loan.
- The borrower inquires about the option to buy discount points.
- The lender explains how much each point will reduce the interest rate.
- The borrower evaluates the upfront cost of buying discount points versus the long-term savings on interest.
- The borrower and lender agree on the mortgage rate and terms, including the discount.
- The cost of the points is rolled into the borrower’s closing costs and paid at closing.
- The borrower ends up reducing their monthly payments and long-term interest costs by securing a lower mortgage rate.
How Much Do They Cost?
One point is equal to 1% of the mortgage amount being borrowed. For a home buyer taking out a $300,000 loan, one discount point would come to $3,000. That’s $1,000 for every $100,000 borrowed, or 1%.
For example, on a $400,000 loan amount a borrower might choose to pay 1.375 discount points ($5,500), or half a point ($2,000). This would reduce the interest rate by varying amounts.
The following table shows the typical cost for different loan amounts:
| Loan Amount | Cost of One Point |
| $300,000 | $3,000 |
| $350,000 | $3,500 |
| $400,000 | $4,000 |
| $450,000 | $4,500 |
| $500,000 | $5,000 |
| $550,000 | $5,500 |
Note: We’ve used round numbers to simplify these examples. But they don’t have to be round numbers.
The takeaway: One discount point typically reduces the borrower’s mortgage interest rate by one quarter of a percent, or 0.25%. But this can vary, so you’ll have to ask your lender about it.
How Do Points Benefit Me as a Borrower?
Points typically have an inverse, or opposite, relationship with mortgage rates. The more points you pay, the lower the interest rate you’ll receive from the lender. This is usually how it works, and it’s why so many borrowers choose this option in the first place.
According to the Consumer Financial Protection Bureau:
“Points let you make a tradeoff between your upfront costs and your monthly payment. By paying points, you pay more up front, but you receive a lower interest rate and therefore pay less over time. Points can be a good choice if you plan to keep your loan for a long time.”
For some borrowers, the highest priority is to reduce the monthly mortgage payments and the total amount of interest paid over time. And this is where discount points come into the picture. By paying points at closing, the borrower can essentially “buy down” the interest rate.
Sure, it means that you’re paying more money up front, on closing day. But it has the potential to save you a lot of money over time, if you stay in the home past the break-even point.
The break-even point plays an important role here. So let’s drill down on that concept…
How Do I Decide if It’s Worth It?
So now you know how mortgage discount points work, and the benefits they can bring. The next logical question is: When does it make sense to use them? This will depend on your short-term versus long-term priorities.
When you apply for a home loan, you can ask your lender to show you how your interest and payments will break down with and without discount points. This will help you weigh the pros and cons.
Most importantly: You need to know when the “break-even” stage will occur. This is when the accumulated monthly savings (from reducing the interest rate) equal the total cost of the points.
This information will help you decide if it’s a worthwhile strategy:
- If you think you’ll stay in the home and keep the loan beyond the break-even, then it might make sense to pay discount points.
- If you think you’ll sell the home and move in a few years, and prior to the break-even date, you probably won’t benefit from using discount points.
To calculate the break-even mark, you’ll need to divide the total cost of the points by the monthly savings. For example, if I have to pay an additional $3,000 up front, and it reduces my monthly payments by $40, it will take me 75 months (five years) to break even.
The formula: $3,000 (cost of points) ÷ $40 (monthly savings) = 75 months
Once I reach the break-even point of five years, I would save money every subsequent month that I owned the home. So this strategy would make sense if I was planning to stay in the home and keep the loan for, let’s say, 10 years or more.
But if I only plan to stay put for four to five years, it doesn’t make sense to use discount points.
Are They Tax Deductible?
Yes, in many cases mortgage discount points are tax deductible. According to the IRS:
“Points are prepaid interest and may be deductible as home mortgage interest, if you itemize deductions on Form 1040, Schedule A, Itemized Deductions. If you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid … If your acquisition debt exceeds $1 million or your home equity debt exceeds $100,000, you cannot deduct all the interest on your mortgage and you cannot deduct all your points.”
But there are some stipulations when it comes to tax deductions. The home in question must be your “main home,” meaning the one you live in most of the time, as opposed to a vacation property.
Additionally, the points you paid must have been “computed as a percentage of the principal amount of the mortgage” and must show up on your settlement statement.
The Home Buying Institute does not offer tax advice. So you’ll need to follow the link provided above to learn more about tax deductions.
Disclaimer: Every mortgage lending scenario is different because every borrower is unique. Because of this, portions of this article might not apply to your particular situation.
Brandon Cornett
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author