What are Mortgage Discount Points?

You know what can bring down even the most optimistic new homebuyer? Those pesky, persistently high mortgage interest rates.

The good news? You might have at least one option for a little bit of relief.

That’s right, we’re talking about mortgage discount points!

Discount points are a financial tool offered by the lender, that may help lower your mortgage interest rate, potentially giving you a rate below the prevailing interest rates in the market.

It might sound too good to be true, but these upfront payments really could help ease the burden of new homeownership over the long haul. 

Here’s a little primer on the all-powerful concept of discount points:

What Are Mortgage Discount Points? 

Mortgage discount points: Upfront payments that borrowers can make at closing in exchange for a reduced interest rate.

One point usually costs 1% of the total loan amount and typically lowers the interest rate by one-quarter of a percent.

For a clearer picture, let’s run some hypothetical numbers.

Say your theoretical 30-year fixed-rate home loan amount is $400,000. Each mortgage point would cost you $4,000.

Now, let’s say your hypothetical interest rate is a fixed 7%. Each point would lower it by .25%.

So, purchasing four points would cost you $16,000. It would also drop your interest rate to 6%.

Discount points are paid at closing, so they can’t be tacked on after the fact or amortized over the life of the loan. If you sign on the dotted line before exploring this option, purchasing discount points won’t be possible. So, make sure any discount points you’d like to purchase are reflected in the loan terms before the deal officially closes!

In this scenario, mortgage discount points go into effect immediately, and the new, adjusted interest rate is in effect for the entire life of the home loan.

After closing, changing your interest rate any further will likely come down to refinancing.

Who Might Be Able To Use Mortgage Discount Points? 

The big benefit of discount points? A lower interest rate, which usually means less money paid over the term of the loan.

How much money? Well, let’s crunch a few more numbers

Bring that hypothetical home back to mind. Imagine it’s valued at $400,000, you’re putting down 20%, and using a conventional, fixed-rate, 30-year mortgage.

With a 7% interest rate, your principal and interest payment would be an estimated $2,129.00 each month. If you could get that down to 6%, though, your monthly principal and interest payment would drop to roughly $1,918.00. It would take roughly 76 monthly payments to recoup the initial $16,000 investment paid towards the discount points.

That’s over $210 less each month — and thousands less over the life of your loan!

Should I Buy Mortgage Discount Points?

Any borrower might be able to apply for and purchase mortgage points. But they can be especially powerful in certain mortgage scenarios.

If any of the following apply to you, purchasing mortgage discount points might be a good idea:

• You can afford to pay at least 1% of your total loan amount upfront. Of course, you’ll need to be able to (comfortably) pay for any mortgage discount points.
• You’re concerned about rising interest rates. If you feel frustrated by rising rates, mortgage discount points could offer some relief.
• You’re not planning on selling the home or refinancing anytime soon. If you invest in mortgage points and then offload your home shortly thereafter, you might miss out on some of the long-term benefits that a lower interest rate can provide.
• You have a fixed-rate mortgage. Borrowers with adjustable-rate mortgages might technically be able to purchase points, too, but it isn’t a common practice. That’s because, as the name implies, the rate is variable and will fluctuate over time anyway. Any points that you purchase for an adjustable-rate mortgage will only discount the initial interest rate of the loan.

When in doubt, run the numbers with a local mortgage pro.

Determine how much you would save each month if your rate were to drop. Then, divide the cost by one point by that dollar amount.

For example, if a point costs $1,000 and would save you approximately $25 per month, you would divide 1,000 by 25, giving you 40.

This answer represents the number of months you’ll need to live in the home and pay on your mortgage loan to save money with a mortgage discount point.

So, in this case, you would need to live in the home for over three years to make the most of your money.

Don’t forget to multiply costs and savings accordingly if you’re thinking about purchasing multiple points.

Wrapping Up: Exploring Mortgage Discount Points

If you’ve decided that mortgage discount points sound right for you, the next step is to speak with a home finance professional. The right mortgage pro can help determine the ideal home loan situation for you, mortgage discount points included.

And hey, now that you know the basics, you’re primed and ready for an informative, productive conversation. Happy exploring!