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Should You Pay Discount Points?

Should You Pay Discount Points?

  • What is a Discount Point?
  • Most lenders offer borrowers the option to pay discount points to obtain a lower mortgage rate than they would otherwise receive.  A discount point is a one-time, upfront fee that equals 1% of the mortgage amount.  For example, if your mortgage amount is $300,000, one discount point would cost the borrower $3,000.  If you pay a half discount point in this example, it would cost $1,500.

    You usually pay for discount points out-of-pocket as an extra closing cost although you may be able to add the point cost to your loan with a financed permanent buy down.  Instead of paying for the points at closing with your own funds, with a financed permanent buy down you add the cost to your mortgage which increases your monthly payment slightly and means you pay interest on that additional cost as well. Because the main reason to pay discount points is to reduce your monthly payment, most people choose to pay for them up-front.

    A discount point should not be confused with an origination point, which is a fee that some lenders charge to process and close your mortgage. Origination points are mandatory if the lender requires them whereas discount points are totally optional for borrowers. To reiterate, it is completely up to you to decide if you want to pay discount points to reduce our mortgage rate and lenders cannot force or require you to pay them.

    In short, if you decide to pay discount points then your mortgage rate should be lower than if you do not pay points, so there is a trade-off.  But how do you compare the cost of a discount point, an up-front fee equal to 1% of the mortgage amount, to the benefit of a lower mortgage rate, the ongoing cost of your loan?  As a rule of thumb, one discount point is equivalent to .250% (1/4 of 1%) in mortgage rate and a half of a discount point is equivalent to .125% (1/8th of 1%) in rate.

    For example, if you receive a mortgage quote with a 4.000% interest rate plus one discount point, this equates to a mortgage proposal with a 4.250% interest rate with zero discount points. If you receive a proposal for a loan with a 4.250% rate plus a half discount point, this is equivalent to a loan with 4.375% mortgage rate and no discount points. You can use this guideline, in addition to other factors including how long you intend to own the home and have the mortgage, to determine if it makes financial sense for you to pay discount points.

  • CalculatorUse our DISCOUNT POINT CALCULATOR to compare loans with different discount points and mortgage rates
  • Your mortgage rate affects both your monthly payment as well as the total interest you pay over the life of the loan. The longer you have your mortgage, the more you benefit from the lower monthly payment and reduced total interest expense that results from paying discount points to lower your rate. You should consider both the short and long term financial impact to make sure that the benefits exceed the discount point cost.

  • Discount Point Example
  • The example below shows the financial impact of paying discount points.  The example compares a scenario where the borrower pays one discount point to a scenario where the borrower does not pay any discount points.  The example looks at a $300,000 30 year fixed rate loan and shows the difference in discount point cost, mortgage rate, monthly payment and total interest expense over the life of the mortgage for the two scenarios.  The example also shows how long it takes to recover the discount point cost.

    In the scenario where the borrower pays one discount point, the borrower pays an extra $3,000 upfront, but reduces their mortgage rate from 4.250% to 4.000%.  The borrower saves $44 per month on their mortgage payment and $15,685 in total interest expense over the life of the loan.   This example shows the benefits of paying discount points in terms of lowering your monthly payment and total interest expense in the long run, especially if you keep your mortgage for the entire 30 year term.

    It is also important to understand how long it takes you to recover the cost of paying for discount points.  In the example below, if you divide the upfront discount point cost of $3,000 by $44 per month in savings, it takes more than 68 months, or more than five and a half years, to recover the cost of the discount point.

    This highlights an important rule of thumb when you are considering paying points: if you are planning on owning the property being financed for more than five years and if paying a discount point reduces your mortgage rate by at least .250%, then paying discount points usually makes financial sense. If you are planning on having the mortgage for less than five and a half years then you may not be able to fully recover the cost of the discount point but you still benefit from the lower monthly payment.

    • Scenario #1: the borrower pays an interest rate of 4.25% and no discount points
    • Scenario #2: the borrower pays an interest rate of 4.00% and one discount point
  • Scenario 1
    (No Discount Points)
    Scenario 2
    (1 Discount Point)
    Difference
    Interest Rate 4.25% 4.00% 0.25%
    Discount Points 0 1 (1)
    Discount Points ($) 0 $3,000 ($3,000)
    ÷
    Monthly Mortgage Payment ($) $1,476 $1,432 $44 = ~68 months to recover cost of discount point
    Total Interest Expense Over Mortgage ($) $231,295 $215,610 $15,685
  • Great Mortgage IdeaIf you plan on owning the property you are financing for less than five years it typically does NOT make sense to pay discount points because you cannot recover the cost in that time period
  • Example: Paying Discount Points to Lower Your Interest Rate
  • The graphs below show how the mortgage rate decreases as the number of discount points increases.  As illustrated by the graphs, a half of a point should reduce the interest rate by .125% (1/8th of 1%) and one point should lower the rate by .250% (1/4 of 1%).  You can use these charts to determine what your mortgage rate should be depending on the number of discount points you pay.  The more points you pay, the lower your rate should be but make sure the reduction in your rate and monthly payment is large enough to justify the cost.

Interest Rate

30 Year Fixed Rate Mortgage

4.375% 3.500% 2.625% 1.750% 0.875% 0%
  • 3.750% 0 Points
  • .5 Points 3.625%
  • 1 Points 3.500%
  • 1.5 Points 3.375%
  • 2 Points 3.250%
  • 2.5 Points 3.125%
  • 3 Points 3.000%
Interest Rate

15 Year Fixed Rate Mortgage

5.000% 4.000% 3.000% 2.000% 1.000% 0%
  • 2.750% 0 Points
  • .5 Points 2.625%
  • 1 Points 2.500%
  • 1.5 Points 2.375%
  • 2 Points 2.250%
  • 2.5 Points 2.125%
  • 3 Points 2.000%

    The table below shows interest rates and fees, including points, for leading lenders in your area.  We recommend that you contact multiple lenders in the table to understand how discount points impact your loan terms including your interest rate.  Comparing mortgage proposals enables you to to determine if you should pay discount points and select the loan that best meets your needs.   

  • Rate Details*
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    Rate:  
    Points  More Info:
    Points: Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
     
    Total Lender Fees:  
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    Monthly Housing Payments
    P & I More Info
    Principal & Interest: A periodic payment, usually paid monthly, that includes the interest charges for the period plus an amount applied to the reduction of the principal balance.
    Mortgage Insurance More Info
    Mortgage Insurance: The monthly cost for a policy that protects the lender in case you’re unable to repay the full amount of the loan. It is typically required for loans that have a loan-to-value ratio between 80% to 100%.
    (Estimated)
    Property Tax More Info
    Property Tax: (Also called "Real Estate Tax.") Property taxes are government assessments on real estate property. With mortgage financing, the local, county or state tax assessment on real estate property is considered part of the monthly housing obligation and typically collected and set aside by the lender ...
    (Estimated)
    Homeowner Insurance More Info
    Homeowner Insurance: or also commonly called hazard insurance, is the type of property insurance that covers private homes. It is an insurance policy that combines various personal insurance protections, which can include losses occurring to one’s home, its contents, loss of its use, or loss of other personal possessions of the homeowner, as well as liability insurance for accidents that may happen at the home or at the hands of the homeowner within the policy territory.lender ...
    (Estimated)
    Homeowner Association Fee More Info
    Homeowner Association fee: (HOA) fees are funds that are collected from homeowners in a condominium complex to obtain the income needed to pay (typically) for master insurance, exterior and interior (as appropriate) maintenance, landscaping, water, sewer, and garbage costs.
    (If Any)
    Total Monthly Housing Payments
    Lender Fees
    Points More Info
    Points Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
    Origination Fee More Info
    Origination Charge: A loan origination charge is a fee charged by the lender for evaluating, processing, and closing the loan.
    Credit Report Fee More Info
    Credit Report Fee: Fee charged to obtain an applicant’s credit history prepared by one or all of the three major credit bureaus. Used by lender to determine the borrower’s creditworthiness.
    Tax Service Fee More Info
    Tax Service Fee: A fee charged by the lender to cover the cost of retaining a tax service agency. These agencies monitor the property tax payments on the property and report the results to the lender.
    Processing Fee More Info
    Processing Fee: A processing fee is a charge by the lender for clerical items associated with the loan. Examples of processing include loan set up, organization of loan conditions for underwriting, and preparing required disclosures for the borrower.
    Underwriting Fee More Info
    Underwriting Fee: A fee charged by the lender to verify information on the loan application, authenticate the property’s value, and perform a risk analysis on the overall loan package.
    Wire Transfer Fee More Info
    Wire Transfer Fee: In most cases lenders wire funds to escrow companies to fund a loan. Commercial banks that perform this function will charge the lender so the fee is generally passed on to the borrower.
    (If Any)
    FHA Upfront Premium More Info
    FHA Upfront Premium: A fee paid in cash at the close of escrow or more commonly it is financed into the loan. These premiums are pooled together by the FHA and are used to insure the risk of borrower default on FHA loans. FHA upfront premiums are prorated over a five year period, meaning should the homeowner refinance or sell during the first five years of the loan, they are entitled to a partial refund of the FHA upfront premium paid at loan inception.
    (If any)
    VA funding Fee (If any)
    Flood Fee
    Other Fees More Info

    Other fees could be either additional Administrative Fees that a lender charges or it could be a Flat Fee to cover all lender charges such as: (Origination Fees, Points, Underwriting and Processing Fees, Credit Reports and Tax Service Fees)

    The flat fee does not include prepaid items and third party costs such as appraisal fees, recording fees, prepaid interest, property & transfer taxes, homeowners insurance, borrower’s attorney’s fees, private mortgage insurance premiums (if applicable), survey costs, title insurance and related services.

    Total Lender Fees
    *Actual rates and other information may vary. Sponsored results shown only include participating lenders. The information you enter on this page will only be shared with lenders you choose to contact, either by calling the phone number or requesting a quote.
    Current Mortgage Rates as of December 11, 2018
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details.
  • Review our Should I Pay Discount Points? video to learn if paying points is right for you.

  • FREEandCLEAR Mortgage Instructional Video

    Should I Pay Discount Points? Instructional Video

  • Sources

    Discount Points: http://www.thehomestory.com/what-you-should-know-about-mortgage-discount-points/

About the author

Michael Jensen, Mortgage and Finance Guru

Michael is the co-founder of FREEandCLEAR. Michael possesses extensive knowledge about mortgages and finance and has been writing about mortgages for nearly a decade. His work has been featured in leading national and industry publications. More about Michael

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