Simple Mortgage Definitions : Discount Points

Discount Points : Explained In Plain English

Simple Definition : Discount Points

When mortgage rate are quoted by a bank, they’re typically quoted with two parts — the mortgage rate, and the number of discount points required to get that rate. The higher the number of discount points, the lower your rate will be.

Discount points are different from “origination points”, which are fees a bank charges to “do your loan”. By contrast, discount points are fees specifically used to buy-down your rate.

On a settlement statement, discount points are sometimes labeled “Discount Fee” or “Mortgage Rate Buydown” and one discount point carries a cost equal to one percent of your loan size.

A few examples of how to calculate discount points follow, assuming a loan size of $200,000 :

  • 1 discount point would cost $2,000
  • 0.5 discount points would cost $1,000
  • 0.25 discount points would cost $500

Discount points can be tax-deductible, depending on which deductions you can claim on your federal income taxes. Discount points paid in conjunction with a home purchase can be 100% deductible in the year in which they’re paid. Be sure to check with your accountant.

How Discount Points Affect Your Mortgage Rate

When discount points are paid, the bank collects a one-time fee at closing in exchange a lower mortgage rate to be honored for the life of the loan. The banks consider this payment to be “prepaid mortgage interest” and, because mortgage interest can be tax-deductible, discount points sometimes come with tax breaks.

Exactly how far your rate will drop with discount points, though, will vary by bank.

As a rule of thumb, paying one discount point will lower your mortgage rate by 0.25 percentage points. Paying two discount points, however, will not always lower your rate by 0.50 percentage points, nor will paying three discount points always lower your rate by 0.75 percentage points.

As an example of how discount points may work on a $100,000 mortgage :

  • 4.50% with 0 discount points. Monthly payment of $507.
  • 4.25% with 1 discount point. Monthly payment of $492. Fee of $1,000.
  • 4.00% with 2 discount points. Monthly payment of $477. Fee of $2,000.

Note that paying points come with a cost, but that it also makes for monthly savings. In the above example, the mortgage applicant will save $15 per month for every $1,000 spent at closing. This creates a “breakeven point” of 67 months.

If you plan to stay in your home longer than 67 months, or don’t think you’ll want to refinance within 67 months, paying points may be a good idea.

Also, be aware that paying discount points will lower your loan’s APR. Your APR is not your mortgage rate. Your mortgage rate is your mortgage rate. Shopping for the lowest APR is not always a good plan.

“Negative” Discount Point Loans (Zero-Closing Cost)

A helpful aspect of discount points is that lenders will offer them “in reverse”. Instead of paying points for access to lower mortgage rates, you can get points from your lender to pay for closing costs or other items due at closing.

The technical term for reverse points is “rebate”. Mortgage applicants can typically receive up to 5 points. However, the higher your rebate, the higher your mortgage rate.

Here is an example of how rebate points may work on a $100,000 mortgage :

  • 4.50% with 0 discount points. Monthly payment of $507.
  • 4.75% with 1 discount point. Monthly payment of $522. Credit of $1,000.
  • 5.00% with 2 discount points. Monthly payment of $537. Credit of $2,000.

Homeowners can use rebates to pay for some, or all, of their loan closing costs. There are multiple reasons to go this route.

The first is that zero-closing cost mortgages reduce the amount of cash required at a closing. Buyers using low-or no-downpayment mortgages may find this option appealing — especially if their savings are depleted or less-than-optimal

Reverse points can be good for a refinance, too. Using rebates, a loan’s complete closing costs can be “waived”, allowing the homeowner to refinance without increasing his loan size. When mortgage rates are falling, this is an excellent way to lower your rate without constantly paying fees.

Should You Pay Discount Points Or Get Them?

The decision to pay discount points or receive them is a personal one, and one which will depend on your individual loan and your circumstances. If you’re planning to move within the few years, paying points could be a losing gamble; you may never reach your breakeven.

Conversely, if you’re unsure of how long you’ll have your home or your home loan, getting reverse points from your bank can make good sense.

Take a look at today’s mortgage rates with and without discount points. Compare and see which loan suits you best. Comparisons are available online with no obligation whatsoever.

About the Author

Dan Green (NMLS #227607) is an active loan officer with Waterstone Mortgage.

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