Paying discount points is a way to lower your mortgage interest rate. Essentially, you pay a lump sum at closing in exchange for a lower interest rate on your mortgage.
Points allow you to spend more now to save later, which is good if you plan to keep your mortgage for a long time and can afford the upfront cost. But for many homebuyers, paying points on your mortgage is a waste of money.
Whether or not paying points is a good idea depends on your circumstances. In this article, I'll answer some common questions we get from our customers to help you decide.
What are mortgage discount points?
Mortgage discount points, also known simply as "points," are fees that homebuyers can pay upfront at closing to lower the interest rate on their mortgage loan.
Paying points is an option that allows you to spend more upfront at closing to save later. The additional fee increases your loan costs and the money you'll need when buying a home. But, in return for the extra fee, you get a lower interest rate, reducing your monthly mortgage payments and saving you money over time.
Consult a mortgage professional at NewCastle Home Loans who can provide personalized guidance based on your situation and help determine if paying points is a good idea.
How much do discount points cost?
Lenders calculate points as a percentage of the loan amount. Generally, one point reduces the interest rate by a quarter of a percent. Also, lenders may offer the option to pay a partial point, such as 0.5 or 0.25 points, which would cost 0.5% and 0.25% of the loan amount.
One discount point on a $300,000 loan would be $3,000, a half point would be $1,500, and a quarter point would be $750.
- $300,000 x 1% = $3,000
- $300,000 x 0.5% = $1,500
- $300,000 x 0.25% = $750
In exchange for paying points upfront, the lender reduces the interest rate, which lowers your monthly mortgage payment.
As a rule of thumb, one point reduces the interest rate by a quarter of a percent. However, the precise amount by which discount points lower the interest rate will vary depending on the lender and the current market conditions when you lock the interest rate with the lender.
Let's say you're considering a $300,000 mortgage with an interest rate of 7%, and the lender offers to discount the rate by 0.25% if you pay 1 point, 1% of the loan amount at closing. An extra $3,000 upfront would lower the rate to 6.75% and reduce your monthly mortgage payment.
The exact amount of the payment reduction depends on the loan amount and term. The term is the loan repayment period (e.g., 30 or 15 years).
View current rates and closing costs, including discount points, with our interactive mortgage calculator.
When should I pay discount points?
Whether to pay discount points depends on your financial situation, goals, and how long you plan to stay in the home. We created a decision tree to help you decide whether or not to pay points on your home loan.
- Do you have the money? Consider paying points only when you can afford them on top of the down payment and closing costs. Don't pay points when your goal is to keep the loan costs as low as possible. Use our mortgage calculator to see closing costs.
- Are points your best investment? Consider paying points to lower the mortgage payments if the return will be better than other investments. Don't pay points if you'll profit more by spending the money on home improvements, a retirement fund, or a savings account.
- Is your rate fixed or adjustable? Consider paying points only if you have a fixed-rate mortgage - your monthly payments of principal & interest won't change. Don't pay points if your adjustable-rate mortgage (ARM) will change before you recover the upfront cost.
- Is your down payment 20% or more? If your down payment is less than 20%, the lender will make you pay mortgage insurance. Rather than paying extra for points, focus on getting rid of mortgage insurance first.
- Will you break even or come out ahead? Calculate the break-even to determine when you'll recover the upfront cost and start saving money. Paying discount points may not make sense if you move or refinance before breaking even.
When will I break even and recover the upfront cost for points?
The break-even point is when the upfront cost of buying discount points equals the accumulated monthly savings from lowering the interest rate.
By calculating the break-even point, you can figure out how long it will take to recoup the upfront cost of the discount points through the savings on your monthly mortgage payments.
Before calculating the break-even point, ask the lender for two mortgage rate quotes —with and without discount points. The quotes should include the loan amounts, interest rates, loan terms, and discount points.
Next, follow these steps to determine when you'll recover the discount points cost.
Determine the upfront cost for discount points. Where are mortgage discount points on the Loan Estimate?
- Figure out the payment difference between the two rate quotes.
- Calculate the break-even point. Divide the cost of the discount points by the monthly savings to find out how many months it will take to recoup the upfront cost.
Follow these steps to determine if you should pay points for a lower mortgage rate, assuming the lender provided two quotes for a $300,000, 30-year fixed-rate mortgage.
1. The upfront cost for discount points is $3,000 for 1 point.
- 7% with no points
- 6.75% with 1 point
2. The payment difference between the two rate quotes is $50.11.
- $1,995.91 Principal & interest @ 7%
- - $1,945.79 Principal & interest @ 6.75%
- = $50.11 Payment difference
3. You would break even in 60 months or 5 years
- $3,000 Upfront cost for discount points
- ÷ $50.11 Payment difference
- = 60 months
Mortgage discount points calculator
Calculate how long it will take to recoup the upfront cost of the discount points through the savings on your monthly mortgage payments.
Why do I have to pay mortgage discount points?
Mortgage lenders may require homebuyers to pay discount points when loans include risky features. If your loan application includes any combination of the following features, the lender may offset the risk by charging you discount points:
- Low credit score
- Small down payment
- Occupancy - buying a second home or investment property
- Property type - purchasing a condominium or 2-to 4-unit property
Let's say you have an Average credit score of 660, and you apply for a conventional mortgage to buy a 2-unit with a 15% down payment. In this case, the lender might require you to pay discount points to offset the risk of lending you 85% to purchase a 2-unit property.
If money is tight, consider asking the seller to pay some closing costs to reduce the money you'll need at closing.
Where are mortgage discount points on the Loan Estimate?
After you apply for a mortgage, the lender will send you an official Loan Estimate. Points are on page 2 of the Loan Estimate under Loan Costs, in section A. Origination Charges.
Origination Charges are the lender's fees, including any points you'll pay to the lender at closing.
When comparing Loan Estimates, weigh the total origination charges against the lender's interest rate. Our Loan Estimate Explainer will help you compare offers and lock in the best deal on a mortgage.
Check out our mortgage calculator. View current interest rates and closing costs. You'll feel better knowing how much a home will cost.
Additional information about mortgage discount points
You can trust the following sources for more information about mortgage discount points.