# What is a discount point on a mortgage?

Raise
your hand if you want to lower your interest rate. Is it possible to
reduce my mortgage rate? Many home buyers are surprised to learn
that mortgage points are not a sinister plot by the
lender to squeeze extra money out of the unsuspecting home buyer, but just a
technique to prepay some of the interest on the loan in order to
lower the overall interest rate.

A point is simply one percent of the loan amount. It is usually paid
in a lump sum when you secure your loan. It may be financed in some
cases. There are two types of points. The first is a discount point,
which can directly lower your interest rate. This is the one you may
want.

Example: You want to borrow $100,000. One lender offers a no points
loan with an interest rate of 4%. Another lender offers a two points
loan at 3.50%. By paying the two points you are buying down the
interest rate. Which loan is better? There are two things you must
consider to determine the answer. One is easy, and the other is
usually not easy.

For the above example, the monthly payment on a 30-year loan would
be $28 less per month on the two point 3.50% loan. It would take a
little less then six years to make the two points loan the better deal.
Use the amortization calculator and enter your specific numbers and
you will be able to figure out the break-even time for the loan
amount and percentages you are comparing.

Discount Point Comparison | 0 Point | 1 Points | 2 Points |
---|---|---|---|

Loan Amount | $100,000 | $100,000 | $100,000 |

Interest Rate | 4.00% | 3.75% | 3.50% |

Discount Points | $0 | $1,000 | $2,000 |

Product Type | Fixed | Fixed | Fixed |

Loan Term (Years) | 30 | 30 | 30 |

Principal & Interest (P&I) Payment | $477 | $463 | $449 |

Payment Difference | $0 | $14 | $28 |

Breakeven (Months) | 0 | 72 | 72 |

Savings | $0 | $4,032 | $8,064 |

Now for the hard part. How long will it be before you payoff the loan? Are you
planning to move within six years (before the break-even time)? If you plan to
move in three years, you would want the no points, 4% loan. If you end up
staying in the property seven years, you would have saved money with the two
points, 3.5% loan. While predicting when you will move in the future is no easy
task, most people underestimate the time they will keep their property.

An advantage to discount points is that they are considered interest and are
currently tax deductible. Since tax laws change frequently, always get advice or
research current deductions for mortgage expenses before filing.

Contrary to common belief and marketing messages, mortgage points do not reflect
the mortgage industry's dark side. When used prudently, they may save you
thousands of dollars over the course of a loan.