Mortgage & Discount Points Explained


Current Mortgage Rates (December 2020)

Loan Term

Interest rate

APR

30-year fixed-rate

3.05%

3.28%

15-year fixed-rate

2.91%

3.06%

5/1 adjustable-rate

3.05%

3.25%

What Mortgage Points?

A mortgage point is a fee charged by a lender; there are two types of points. Discount points and origination points. A mortgage point is equal to 1% of the loan amount. For instance, if you have a $300,000 loan, a point is $3,000, or 1%.

Origination Points

Origination points are a fee charged by the lender to compensate for the loan officer. However, not all lenders will charge points. Sometimes mortgage points are referred to as an origination fee, but they are the same thing. On average most lenders charge approximately 1 origination point. These mortgage points are not tax-deductible.

Discount Points

Discount points are pre-paid interest on a loan. The mortgage rate will be reduced by up to a quarter of a percent for each discount point. The amount of rate reduction per discount point varies between lenders and market conditions.

Because you are paying less interest, your monthly mortgage payments will be lower as well. Most lenders will allow you the opportunity to buy up to 4 discount points and are tax-deductible.

When is it a Good Idea to Pay for Discount Points?

 When deciding whether to pay for discount points, you first need to know how long you plan to live in the home. If you plan to sell the home or pay off the loan within 5 years, then discount points are useless and could end up costing you more. However, if you plan on staying in the home for a long time, using some discount points will save you a lot of money in interest.

For example, a $250,000 home loan with an interest rate of 4.5% will have a payment of $1,610. If you purchase 4 points for a total of $10,000, bringing your interest rate down to 3.5%, the total monthly payment is reduced to $1,466. This is a savings of $154 per month—around $1,850 per year. The points will pay for itself in 55 months and will save you $55,440 over the course of a 30-year loan.

How discount points affect your monthly payment ($100,000 loan amount)

Assuming 1/4 rate drop per discount point

  • 0 discount points – Rate 4.5% – Payment $507 – $1,000 upfront
  • 1 discount points – Rate 4.25% – Payment $492 – $1,000 upfront
  • 2 discount points – Rate 4.0% – Payment $477 – $2,000 upfront
  • 3 discount points – Rate 3.75% – Payment $463 – $3,000 upfront
  • 4 discount points – Rate 3.5% – Payment $449 – $4,000 upfront

 

The monthly payment is reduced by about $15 for every point you purchase for every $100,000 loan amount.

The Bottom Line

Deciding whether or not to buy discount points is something that depends on the borrower.

Don’t pay for discount points if you know you are not staying in the home for 5 years or more.

If you plan on staying in the home for more than 5 years, then discount points can save you tens of thousands of dollars over the life of your mortgage.

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