“Mortgage discount points” are paid by borrowers at closing to reduce the interest rate on a home loan.
They are considered a form of prepaid interest, as the upfront cost lowers the interest rate during the loan duration (that also means they’re tax deductible).
Borrowers pay a percentage of the loan amount to lower the interest rate by a certain amount, though it’s not a perfect science.
Let’s look at an example:
Loan program: 30-year fixed
Loan amount: $200,000
Par rate: 5.00%
Desired rate: 4.50%
We’ll assume you qualified for a rate of 5.00% with no costs, aside from a loan origination fee of 1%. But you want to snag a lower rate, say 4.50%. In order to do so, you’ll need to come up with more money at closing.
The mortgage broker or bank may say you need to pay two discount points to lower your interest rate by a half-percent.
That would mean a cost of $4,000 ($2000 x 2) in mortgage discount points to obtain the desired rate. So instead of making higher mortgage payments each month, you’d pay more at closing.
This favors the mortgage lender because they get more money upfront, and you, assuming you stick with the loan long-term.
Does it make sense to buy down my rate using mortgage discount points?
You need to make sure it actually makes sense to buy down your interest rate – the answer will vary greatly depending on how much it costs to buy down the rate, and how long you plan to stay with the mortgage/in the home.
As I mentioned earlier, mortgage discount points aren’t a perfect science, meaning it could cost three points to lower your interest rate one percent, or just two points to lower it three-quarters of a percent.
So make sure you ask about all types of different combinations to ensure you get the most out of your mortgage discount points.
Tip: Don’t focus on a certain interest rate, as the cost may not justify the discount.
