Discount Points and How They Work on Your Mortgage

How to lower your interest rate with discount points

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Mortgage points are points you can purchase to lower your mortgage interest rate. You pay more in closing costs in exchange for an interest-rate reduction that can bring significant savings.

Learn how mortgage discount points work, how they can help you save money, and about some alternative ways for lowering your interest rate.

Key Takeaways

  • When you buy a mortgage point, you can lower your mortgage interest rate.
  • Buying a mortgage point costs 1% of the loan amount.
  • The amount that a mortgage point will reduce your interest rate varies by lender, type of loan, and loan market.

What Are Discount Points on a Mortgage?

When you buy mortgage points, you pay an upfront cost at closing time in exchange for a lower interest rate that will help you reduce your monthly payments and save in total interest.

If you intend to keep your home for many years, the savings with discount points can be significant. However, if you believe you’ll only live in your home for a short time, the savings may not be enough to offset the cost of the mortgage points.

One mortgage point equates to 1% of the loan amount. For example, if you take out a $200,000 mortgage, one mortgage point would be worth $2,000.

If you don’t buy any mortgage points, you will have a zero-point loan. Once you purchase a mortgage point, you will have a loan with one point, and your interest rate will be lower than the rate with the zero-point loan. The loan term, loan amount, and other features of the loan will remain the same—the only difference would be the interest rate.

How much lower an interest rate is because of a mortgage point varies by lender, the current mortgage market, and the type of mortgage loan. Depending on these factors, a mortgage point can reduce an interest rate significantly or insignificantly.

Types of Mortgage Points and Credits

Mortgage points are not the same as lender credits and origination fees for mortgage points.

A lender credit works like a mortgage point but it has the opposite effect on your interest rate. When you buy a lender credit, you end up paying a high interest rate. In exchange, the lender will give you money to help offset your closing costs. Essentially, you’re still paying your closing costs—they’re just spread out over the life of your mortgage loan in the form of a higher interest rate.

With mortgage origination points, you pay as a part of your closing costs and they are designed to pay your lender for processing and approving your loan. Essentially, a mortgage origination point is just an origination fee, but is calculated differently. One origination point is equal to one percent of your total loan amount.

Calculating Your Savings From Discount Points

Before you decide to buy a mortgage point, do the math to make sure that the points you are considering buying will be worth it. How long you plan to keep the home will play a big role in whether or not you get your money’s worth.

If you intend to keep this home for the long term and plan to make 30 years worth of payments, you’ll likely see a return in savings. On the other hand, if you sell the home within a few years, you may not recoup your costs.

You can lower your interest rate in other ways as well. Shop around with different lenders because some may charge less interest. You can also work to improve your credit score—for example, by paying down debt. You can also get lower interest rates with a larger down payment or shorter loan term.

Let’s look at an example of how discount points work. Say you have a $180,000, 30-year, fixed-rate with an interest rate of 5%. Let’s compare that to the same mortgage, but with 0.375 worth of mortgage points that reduce your rate to 4.875%.

  With 0.375 discount points No points
Rate 4.875% 5.0%
Points 0.375 0
Result You pay $675 more in closing costs. Your interest rate will lower to 4.875%, which means you’ll pay $14 less each month over the life of your loan. Closing costs and monthly mortgage costs remain the same.
Interest savings $5,040 $0
Total savings $4,365 $0

Alternatives to Discount Points

If you want to avoid increasing your closing costs so you can use your money for other expenses, you do have other alternatives for lowering your interest rate.

  • Shop around: Each lender offers different interest rates on mortgages. Compare interest rates from several lenders to find the best rates and terms for you.
  • Improve your credit score: If you can delay buying a home a bit, you can work on boosting your credit score. A higher credit score shows lenders you are a lower-risk borrower, so you often qualify for a lower interest rate. To raise your score, you can, for example, pay off debts, make on-time payments to your creditors, and fix any errors on your credit report.
  • Choose a shorter mortgage term: If you can manage the higher monthly payments that come with a shorter mortgage term, your lender will likely give you a lower interest rate. A shorter mortgage term lowers the risk for the lender.
  • Make a large down payment: There’s no cap on how large of a down payment you can make, and the bigger your down payment is, the lower your interest rate tends to be. Plus, you’ll be borrowing less principal for the lender to charge interest on.

Should You Buy Discount Points?

You can benefit from mortgage points if you plan on keeping your home long enough to offset the cost of buying them. Calculate how long it would take you to make your money back compared to how long you plan to own the home to determine if you should buy mortgage points.

If you plan on owning the home long-term, buying mortgage points might make sense for your finances. If you plan on selling the home in the near future, mortgage points may not pay off.

Frequently Asked Questions (FAQs)

How much is one discount point worth?

One mortgage discount point equals 1% of the mortgage loan amount. So if you have a $300,000 loan, it will cost you $3,000 to buy a mortgage point. The interest-rate discount you receive with a mortgage point varies by lender.

What is a basis point in a mortgage?

A basis point is used when referring to interest-rate changes. One basis point is one one-hundredth (0.01) of a percentage point. So, 500 basis points is equal to 5%. If an interest rate changes from 5% to 5.25%, it has increased by 25 basis points.

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