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What Mortgage Borrowers Should Know About Discount Points
What is a Discount Point
A discount point is an optional fee that borrowers can elect pay to lower their mortgage rate. One discount point costs the borrower 1.0% of the mortgage amount. For example, one discount point on a $250,000 mortgage costs the borrower $2,500 ($250,000 * 1.0% = $2,500). Borrowers pay discount points to "buy down" or lower their mortgage rate. Lenders usually offer borrowers the ability to pay discount points in half-point increments up to a certain limit so you can pay a half of a discount point, one discount point, one and a half discount points, and so on.
What is a Discount Point Worth?
One discount point typically equates to a .250% reduction in interest rate. For example, if a lender quotes you a 4.000% mortgage rate with no discount points, your mortgage rate if you decide to pay one discount point should be 3.750% and 3.500% if you decide to pay two discount points. The more discount points you pay, the lower your mortgage rate should be and the lower your monthly mortgage payment should be. Borrowers should make sure that each discount point they pay reduces their mortgage rate by at least .250%. Additionally, borrowers should compare mortgage proposals with different interest rates and discount points for multiple lenders to find the loan with the best terms. Comparing mortgage proposals also enables borrowers to verify that discount points are "worth" the same across multiple lenders are result in the same reduction in interest rate.
When You Should Pay Discount Points
Discount points are an upfront cost that you recover by paying a lower monthly mortgage payment which means you recover the cost of the discount points over time. For example, you may decide to pay $3,000 for one discount point to reduce your monthly mortgage payment by $50, or $600 per year. In that scenario, you recover the cost of the discount point in five years -- $3,000 (cost of discount point) / $600 (savings per year) = 5 years to recover the cost of the discount point. As a general rule, because of the length of time it usually takes to recover the cost of discount points, you should only pay discount points if you plan to own the property you are financing for at least five years. The amount of time it takes to recover the cost of discount points varies depending on your interest rate, mortgage amount and the number of discount points you pay but in general it does not make sense to pay discount points if you intend to sell your home and pay off your mortgage in less than five years.
Discount Points are 100% Optional for Borrowers
It is completely up to borrowers to decide if they want to pay discount points. Although discount points are charged by the lender they are totally optional and borrowers ultimately decide if they want to pay them based on their financial objectives. Discount points should not be confused with origination points or other mandatory fees lenders charge to process your mortgage.
More FREEandCLEAR Mortgage Resources
Review our in-depth explanation of mortgage discount points including an example that compares the monthly mortgage payment and total interest expense over the life of a loan for a mortgage with and without discount points
Compare mortgage rates and fees from top lenders near you. Comparing proposals from multiple lenders is the best way to save money on your mortgage
Review our comprehensive overview of mortgage closing costs including an informative example. Understanding how much mortgage closing costs are may affect your decision to pay discount points
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