What a discount point is
A discount point is an upfront fee you pay the lender at closing in exchange for a lower interest rate. One point costs 1% of the loan amount, so one point on a $300,000 loan is $3,000. Lenders also quote fractions, such as half a point.
How much each point lowers the rate is not fixed. It varies by lender, loan program and the market on the day you lock, so compare the rate with and without points on each lender's quote. On a Loan Estimate, points appear under Origination Charges as a percentage of the loan amount.
Points can also run the other way. A lender credit is a payment from the lender toward your closing costs in exchange for a higher rate, which suits a borrower who expects to keep the loan only a short time.
The break-even point
Points pay off once the monthly savings from the lower rate have added up to what the points cost:
- Break-even (months) = cost of the points ÷ monthly payment savings
As an illustration: if one point costs $3,000 and lowers the monthly payment by $50, you break even after 60 months, or 5 years. Keep the loan longer and the points have paid for themselves; sell, refinance or pay the loan off sooner and they have cost you money.
There is a second way to count. A lower rate also means more of each payment goes to principal, so your balance falls faster. Counting that faster paydown alongside the payment savings gives an earlier break-even than the payment savings alone. Both answers are worth seeing: the first is about cash flow, the second about total wealth.
When points tend to make sense
- You expect to keep this loan well past the break-even point, with no move or refinance in view.
- You have cash left over after the down payment, closing costs and a healthy emergency fund.
- Rates are not expected to fall soon. If they do fall and you refinance, the points you paid on the old loan stop paying back.
They tend not to make sense if you may move within a few years, if the money would otherwise go toward a larger down payment that avoids mortgage insurance, or if paying them would leave you short of cash.
Details that change the answer
- Adjustable-rate loans. Points usually lower the starting rate. Ask the lender whether they also lower the rate after adjustments begin, or only during the initial fixed period.
- Who pays. On a purchase, a seller can sometimes pay for points as a concession, within limits set by the loan program. Points paid with someone else's money change the decision completely.
- The alternative use of the cash. The same money could go toward a larger down payment, or stay invested or in savings. The points have to beat that, not just zero.
- Taxes. Points can be tax-deductible in some cases, and the rules differ for a purchase and a refinance. Ask a tax professional before counting on a deduction.
Running the numbers
The Mortgage Discount Points Calculator works for a purchase or a refinance. Enter the price or property value, down payment or loan amount, loan term and base rate, and set how much each half point lowers the rate, using your lender's quote rather than the default. You can also enter a seller credit toward the cost. It shows the upfront cost and monthly savings for each level of points, the cash break-even and the total-return break-even side by side, and the net benefit over time. It can also include the tax effect if you itemize deductions. Your lender's Loan Estimate gives the actual cost of points and the rate they buy.