Paying discount points for a mortgage is an option that allows home buyers to spend more now to save later.
In certain circumstances paying more upfront at closing saves you money over time. But discount points aren't worth it for most home buyers, especially first-timers.
This article answers some questions our customers are asking about mortgage discount points. First, look it over. Then for personalized service, schedule a time to talk with a home loan expert.
- What are mortgage discount points?
- How much do discount points cost?
- When should I pay discount points?
- When will I break even by recovering the upfront cost for points?
- Why do I have to pay points for a mortgage?
- Where are "points" on the Loan Estimate?
What are mortgage discount points?
A discount point or "points" is a fee you pay to a mortgage lender to reduce the interest rate on your home loan.
Paying points is an option that allows you to spend more now to save later.
Points increase your loan costs and the money you'll need when buying a home. But, in return for the extra fee, you get a lower rate and monthly payment which could save you money over time.
How much do discount points cost?
Lenders calculate points as a percentage of the loan amount. One point equals 1% of the loan amount.
As a rule of thumb, one point reduces the interest rate by a quarter of a percent. For a $100,000, 30-year fixed rate mortgage, 1 point costs $1,000, reduces the rate by 0.25%, and lowers the monthly payment by $15.
In practice, however, the exact number of points you'll pay to reduce the rate fluctuates because mortgage rates change continuously. So ask the lender for a rate quote for the actual cost. Or, check our mortgage calculator for instant and accurate interest rates and closing costs.
When should you pay discount points?
We created a decision tree to help you decide whether or not to pay points on your home loan.
- Do you have enough money? You'll need enough cash at closing to pay for the down payment and closing costs, including the discount points.
- Are points your best investment? Consider improving the property, saving your money, or spending it on something that will give you a better return on your investment.
- Is your rate fixed until you recover the upfront cost?
- Is your down payment 20% or more? The lender will make you pay mortgage insurance if your down payment is less than 20%. Focus on getting rid of mortgage insurance first.
- Will you break even or come out ahead? Calculate the break-even to figure out when you'll recover the upfront cost and start saving money.
When will you break even by recovering the upfront cost for points?
A simple break-even calculation helps when comparing mortgage quotes.
The break-even point is when the upfront cost of buying discount points equals the accumulated monthly savings from lowering the interest rate.
Follow these steps to figure out when you will break even:
- Ask the lender for a rate quote with zero points. Then ask for a second quote with points so you can see how much they cost.
- Calculate the difference between the monthly payments to see how much you'll save each month by paying points upfront.
- Divide the cost for points by the monthly payment difference to see how long it will take to break even.
For example, for a $100,000 loan, the lender is offering a mortgage at 5% with no points. One point will reduce the rate by 0.25% to 4.75%.
|Loan Amount / Term||Cost of point (1% of loan amount)||Interest rate reduction|
|$100,000 / 30yr||$1,000||.25%|
|Monthly Payment (principal and interest)||Interest Rate|
|Total Monthly Savings = $15||.25% (1 point)|
|Cost of Point||Monthly Savings|
|$1,000 / $15 = 67 month or about 5 1/2 years|
The break-even point is in about 5 ½ years. After that, the discount points work to your advantage by saving you $15 per month for the remaining 24 ½ years or until you terminate the loan.
Why do lenders sometimes require borrowers to pay points for a mortgage?
Depending on your situation, the lender might require you to pay discount points.
Certain risk factors increase the cost of a mortgage. When the lender can't raise the interest rate to cover the cost, they pass it on to you by charging discount points.
When your loan includes any of the following determinants, you might have to come up with additional cash to pay discount points:
- Low credit score
- Small down payment
- Second home or investment property
- Condominium or multi-family (2-to 4-unit property)
If money is tight, consider asking the seller to pay some closing costs to reduce the amount of money you'll need at closing. For most types of loans, the seller can give you as much as 3% to 6% of the property's sales price. Be sure to negotiate the seller's credits upfront when making an offer to buy the house. Read more about seller credits.
Where are "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, 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 interest rate the lender is offering you.
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.
Mortgage questions? We can help. Schedule a call with a home loan expert for answers.