Paying discount points means spending more at closing to lower your mortgage rate. That can make sense if you expect to keep the loan long enough to recover the upfront cost through lower monthly payments, but it can be a poor tradeoff if cash is tight or you may refinance, move, or pay off the loan sooner.
You’re working on your new home loan, and you’ve been offered something called “discount points.” What are they, how do they work, and are they a good option? Below, we explain how discount points work, how to think about the break-even point, and how to compare points with other uses of your cash at closing.
In most cases, mortgage discount points are fees you pay your mortgage lender to reduce the interest rate on the loan. If you are “buying down the rate,” each point that you buy typically costs one percent of the mortgage amount. Each point is worth around a quarter of a percent of interest for the life of your loan (the worth of the point will vary by lender.)
You’ll be informed of your option to buy mortgage points well before closing, and if you decide to buy discount points, they will be listed on your closing disclosure, which you receive and sign at least three days before your closing date.
The main reason to buy discount points when buying a home is that you can save a lot in interest over the life of your loan.
Mortgage discount points are generally treated as prepaid interest, but their tax treatment depends on your circumstances and applicable tax rules. According to the IRS, points paid to obtain a mortgage on your principal residence may be deductible in the year you pay them if you use the cash method of accounting, and deductible mortgage interest is generally claimed on Schedule A (Form 1040). Because eligibility and timing can vary, treat this as general educational information and confirm your situation with current IRS guidance or a qualified tax professional.
A simple way to estimate whether buying points may be worth it is to divide the upfront cost by your monthly payment savings.
Using the example above:
That means you would need to keep the loan long enough for the monthly savings to recover what you paid at closing. If you expect to sell, refinance, or pay off the mortgage before that point, buying discount points may not deliver the savings you want.
The advantages of discount points only apply if you stay in your home long enough to recoup the payout at closing. If you refinance or sell the house within a few years, the mortgage points don’t help you.
In the example above, the savings accumulate monthly to the tune of a $56 lower mortgage payment. To recoup the $4,000 you paid at closing, you’d need to stay in the house at least 71 months. If you sold or tried for a refinance in less than 70 months (almost six years) you lose your advantage.
If you’re comparing discount points with other closing-cost choices, ask yourself where your cash will help you most.
Another type of mortgage points is called “origination” points. Unlike discount points, these are charged by lenders who originate, review, and process your loan. They also usually cost one percent of the total mortgage.
If your lender charges 1.5 origination points on a $200,000 mortgage, you’d have to pay an extra $3,000 at closing. You can try to negotiate these down, or you can look for a mortgage company and lender that doesn’t charge origination points.
Origination points are not tax-deductible, since they are considered a service fee and not prepaid interest.
If you can afford to buy discount points when buying a home, and plan to stay in the home long term, you can save a lot of money. If you’re short on your down payment, or can bump yourself over a lower interest threshold by increasing your down payment, it might be better to use your extra money that way instead.
Consider your future, how long it would take you to break even, and the advantages and disadvantages of buying discount points carefully before you make your decision. Your Sammamish loan officer can help you if you have any questions.
Sammamish Mortgage can help. We serve clients across Washington, Idaho, Colorado, Oregon, and California. Since 1992, we’ve been providing several mortgage programs and products with flexible qualification criteria to borrowers across the Pacific Northwest. Visit our website to get an instant rate quote or to use our online mortgage calculator. Or, reach out to us if you are ready to get pre-approved for a mortgage.
Discount points are upfront fees paid at closing to lower your mortgage interest rate. In many cases, one point costs 1% of the loan amount, and each point may reduce the rate by about 0.25%, although the exact pricing and rate reduction vary by lender.
A common example is that two discount points lower the rate by about 0.50% total, but the exact reduction depends on the lender and the loan pricing offered at that time.
On a $200,000 mortgage, one point would typically cost $2,000. If you bought two points, the upfront cost would usually be $4,000. In the example discussed, that lowered the rate from 4% to 3.5%.
A simple way is to divide the upfront cost of the points by the monthly payment savings. For example, if points cost $4,000 and lower the payment by $56 per month, the break-even point is about 71 months.
It can be worth it if you expect to keep the loan long enough to pass the break-even point. It may be a poor tradeoff if cash is tight or if you may refinance, move, or pay off the loan sooner.
Buying points usually makes more sense when you plan to stay in the home or keep the mortgage for a long time, and when the monthly savings are likely to recover the upfront cost before you refinance, sell, or pay off the loan.
That depends on where your cash helps you most. In some cases, keeping funds for the down payment, reserves, repairs, or other financial priorities may be more useful than prepaying interest through discount points.
The number of points available varies by lender and loan pricing. Borrowers are typically offered point options before closing, and the exact cost and rate reduction should be reviewed carefully on the loan estimate and closing disclosure.
Mortgage discount points are generally treated as prepaid interest, but deductibility depends on your circumstances and current tax rules. The IRS says points paid to obtain a mortgage on a principal residence may be deductible in the year paid if qualifying requirements are met. A qualified tax professional can help confirm how the rules apply.
Discount points are paid to reduce the mortgage interest rate. Origination points are lender fees for originating, reviewing, and processing the loan. Origination points do not buy down the rate and are generally treated as service fees rather than prepaid interest.
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