Mortgage Discount Points: Are They Worth the Cost?

When financing a home, discount points can be a strategy to lower the interest rate on your mortgage. By reducing your interest rate, you can potentially lower your mortgage payment and the interest you pay over the life of the loan. 

Mortgage discount points are an option available to prospective borrowers to help make their monthly payments more affordable. These discount points, almost always known as mortgage points or origination points, are fees you pay upfront to reduce your interest rate. However, whether or not you should buy them depends on the fees, the mortgage rate reduction and how long you plan to live in the house.

One discount point usually costs 1% of the loan amount. You can buy more than one point or a fraction of a point.

The lender calculates the cost of these points and you pay them as a form of prepaid interest along with your closing costs. Another option is to roll the cost of the points into your mortgage, but this also increases the amount you borrow.

“For the consumer, the best way to understand points is as an additional cost to get a certain interest rate at a certain time,” says Matthew Ricci, home loan specialist at Churchill Mortgage. “It is important to note that while often that cost is being used to get a lower rate to help them save money monthly, it is not always the case.” At certain times, some loan products will have points no matter which interest rate the lender provides.

There are also a maximum number of points you can purchase, but ask your loan officer about specifics. “There are federal regulations that limit the amount of fees a borrower can pay – even if they want to,” says Craig Garcia, president at Capital Partners Mortgage Services. “There have been instances where there are rates available but due to federal regulation, the borrower may not pay them.”t

One point can lower your interest rate by 0.25%. For example, purchasing two discount points would reduce the interest rate by 0.50%. If the lender offers a 6.5% interest rate on your home loan, then the two points would bring the rate down to 6%. 

This can significantly impact monthly mortgage payments, particularly over the long run. On a $400,000 mortgage, a 6.5% interest rate would be about $2,528 per month. Buying two mortgage points would cost $8,000, but it would reduce the monthly payment to $2,398, a monthly savings of $130.

According to the Consumer Financial Protection Bureau (CFPB), the amount your interest rate is reduced also depends on the lender, the kind of loan and the overall mortgage market.

Buying discount points makes financial sense in some situations, but not all.

Garcia recommends purchasing discount points if you’ll see monthly savings and you intend to retain the financing long term, or long enough to at least get your initial investment back. However, if you plan to sell the home or refinance within the next few years, Anna DeSimone, an expert in mortgage compliance, predatory lending, discrimination and fraud, recommends the zero-point mortgage instead. 

A zero point mortgage is a home loan with no discount points. According to the CFPB, a loan with one point should have a lower interest rate than a zero point loan, assuming both loans are offered by the same lender and are the same type of loan.

• Length of homeownership: If you plan to move before you recoup what you paid, purchasing mortgage points doesn’t make financial sense.
• Interest rate environment: How much the discount points reduce your interest rate depends on the loan and the overall interest rate environment.
• Financial situation: Your available cash for a down payment, personal circumstances, long term projections, transactional details, monthly budget and payment constraints should all be factored into the decision.

The “break-even point” is the length of time it will take for you to recover what you paid for the mortgage discount points. You can calculate how many months it will take to break even by dividing the price of the discount point by the amount that you’ll save each month. For example, if a mortgage point that costs $4,000 will save you $65 per month, it will take a little more than five years to break even. 

“Whether you are borrowing $100,000 or $500,000 the mathematical formula is quite simple — it takes just about five years for borrowers to ‘recoup what they paid for points,’” says DeSimone.

• Long-term savings: Purchasing discount points can lower the interest rate on your loan. This leads to lower monthly payments and less interest paid over the loan term.
• Tax benefits: It may be possible to save on your tax bill by itemizing your tax deductions. The Internal Revenue Service (IRS) allows homeowners to deduct the full amount paid toward mortgage points in the year you paid them.

• Upfront cost: Discount points are another expense that can add thousands of dollars to your closing costs or mortgage.
• Time to realize savings: You can reduce your monthly mortgage payments, but it will take several years to recoup the upfront expense.

Some home loans come with discount points, while others, such as the zero-point mortgage, have no points added. Mortgage lenders may also offer borrowers the option to buy mortgage points. In some cases, it’s possible to negotiate discount points or even finance them.

“Because of the economic formula, you can’t negotiate a lower rate of interest because you are willing to pay points,” DeSimone says. “However, you can choose your option to go with a zero-point program, or opt for a better rate by paying one or two points.”

The lender determines the cost of each point and how much it lowers the annual percentage rate (APR). However, you may be able to show a lender a better deal you received elsewhere and negotiate from there.

“Keep in mind many people buying investment properties, or second homes or many other scenarios may not be given a choice of not paying discount points,” Garcia adds.

A real estate agent can help you navigate transactional costs and potentially negotiate a better deal.

Generally, there are two options when it comes to how you pay for your discount points. You can either pay the points at closing or roll them into your loan balance. Any discount points you buy will appear on the loan estimate document, which you will receive within three business days of filling out the mortgage application. They will also appear in the closing disclosure that you’ll receive at least three business days before closing.

Before paying for discount points, do the math to determine whether you’ll save money in the long run. Discount points can potentially lower your monthly mortgage payment and the interest you pay over the loan term. But if you plan to sell or refinance before you recover your initial investment, it won’t make much financial sense.

Consider speaking with a mortgage or financial advisor if you have specific questions or need additional guidance.