What is a discount point on a mortgage and will it save me money?

No points ban symbolRaise 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 Comparison0  Point1 Points2 Points
Loan Amount$100,000$100,000$100,000
Interest Rate4.00%3.75%3.50%
Discount Points$0 $1,000 $2,000
Product TypeFixedFixedFixed
Loan Term (Years)303030
Principal & Interest (P&I) Payment$477 $463 $449
Payment Difference$0 $14 $28
Breakeven (Months)07272
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.