Should you pay discount points on your mortgage?

Paying discount points upfront can lower your mortgage interest rate and reduce your monthly payment — but only if you stay in your home long enough to recoup the cost. One discount point typically costs 1% of your loan amount and lowers your rate anywhere from 0.125% to 0.25%.

To decide whether points are worth it, calculate your break-even point: divide the upfront cost by your monthly savings. If you plan to stay past that break-even date, discount points save you money.

What are discount points?

When buying a home, you'll look at plenty of interest rates and mortgage options to figure out the best way to finance your purchase. Over the course of your research, you might come across the term "discount points."

You may also come across the term "mortgage points." There are two types of mortgage points, discount points and origination points.

• Discount points are an upfront cost you could pay to get a lower interest rate over the life of your mortgage.
• Origination points are a fee the lender charges to process and underwrite your loan. They do not lower your interest rate.

Discount points may work for you if the savings from lowering your interest rate outweigh the cost of paying for the points.

How discount points work

Discount points are prepaid interest that borrowers can choose to pay at closing to obtain a lower mortgage interest rate. Each discount point costs 1% of the loan amount. The amount by which your interest rate is reduced will vary based on market conditions, loan type, loan term, and lender pricing. While there is no fixed reduction, paying one point often lowers the interest rate by approximately 0.25% or more. That means if you have a $350,000 mortgage, one discount point would cost $3,500. And if the interest rate without points was 6.5%, paying one point might lower the rate to 6.25%.

Some borrowers choose to pay points to lower their monthly payment and reduce total interest costs over the life of the loan. Others may prefer to conserve cash at closing and accept a higher interest rate.

How to calculate your break-even point

Now that you know what discount points are and how they work, you can figure out if they will save you money.

To answer that, you'll need to start by calculating your break-even point. This is when your monthly interest savings equals the upfront cost you'd pay for the discount point(s). You can calculate this using a simple formula:

Break-even point (in months) = Cost of discount point(s) ÷ Monthly payment savings

Let's go back to the example above. If you have a $350,000 mortgage with a 6.5% fixed interest rate over 30 years, your monthly payment (principal and interest) would be about $2,213. If you purchased one discount point for $3,500 and your interest rate dropped to 6.25%, your monthly payment would be about $2,155, which comes to about $58 in savings each month.

So, going back to the formula:

$3,500 ÷ $58 = approximately 60 months (five years)

In this scenario, if you didn't plan on living in the home for more than 60 months, a discount point would not fully pay for itself. However, every additional month you live in the home beyond those 60 months would yield savings.

When discount points make sense — and when they don't

Deciding whether to pay discount points really comes down to two factors: how long you plan to live in the home and whether you can afford the upfront cost.

In some cases, it may make more sense to put additional money toward your down payment instead of paying for discount points, especially if it brings your down payment up to the 20% threshold that eliminates the need for mortgage insurance. But no matter the circumstances, the only way to find out if discount points make sense is to pull out your calculator and crunch the numbers.

Frequently asked questions

How much does one mortgage discount point cost?

Mortgage discount points are calculated as a percentage of your loan amount. One discount point equals 1% of the loan amount.

Examples:

• $300,000 loan = 1 point costs $3,000
• $500,000 loan = 1 point costs $5,000
• $800,000 loan = 1 point costs $8,000

Many lenders also offer fractional points, allowing borrowers to buy down their interest rate by paying less than a full point.

Are discount points tax deductible?

Discount points may be tax deductible because they represent prepaid mortgage interest. However, the deductibility depends on your individual tax situation and whether you itemize deductions. Consult with your tax advisor to find out if this applies to you.

What is the difference between discount points and origination points?

Discount points are a fee you pay to lower your interest rate, and they directly reduce your monthly mortgage payment. Origination points are a fee the lender charges to process and underwrite your loan. Origination points do not lower your interest rate — they are a cost of obtaining the mortgage.

Take the next steps on your path to homeownership

Buying a home is a large expense. That's why it's important to find the best financing option for you to help fit this expense into your budget. To learn more about discount points and if they're right for you, speak with a Citizens Loan Officer.