What are mortgage discount points and how do they work?

Dan Green
The Mortgage Reports contributor

What are mortgage points?

Mortgage points or “discount points” allow you to pay more in closing costs in exchange for a lower mortgage rate. This means you’d have a bigger upfront fee but a lower monthly payment over the life of your loan.

Typically, the cost of one mortgage point equals 1% of the loan amount, and this single point lowers your interest rate by about 0.25%.

For example, if your loan amount is $300,000 and you’re offered a 3% mortgage rate, you might buy one discount point for $3,000 to get a 2.75% interest rate instead.

If you plan to keep the loan long-term, mortgage points are a great way to save money over the life of your loan.

Check your mortgage rates (Dec 5th, 2021)

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How mortgage points work

When you check current mortgage rates from lenders, you’ll often see three different numbers listed: interest rate, APR, and ‘points.’

Points — also called ‘mortgage points’ or ‘discount points’ — are fees specifically used to buy-down your rate.

Each discount point costs 1% of your loan size and typically lowers your mortgage rate by about 0.25%.

This means when you’re looking at a rate quote that includes points, you’d have to pay extra upfront to actually get the rate shown.

For example, imagine you’re taking out a $300,000 mortgage loan. Here’s how your interest rate might look with and without mortgage points:

Mortgage Points Upfront Cost To Buy Points Interest Rate Total Interest Paid Over 30 Years
0 $0 3.50% $185,000
0.5 $1,500 3.375% $177,500
1 $3,000 3.25% $170,000
2 $6,000 3.0% $155,300

Interest rates shown are for sample purposes only. Your own mortgage rate and fees will vary. Get a custom rate estimate here.

The cost of buying discount points adds up quickly. But as you can see in the example above, the long-term savings can be substantial.

However, if you only plan to stay in the home a few years, the upfront cost of buying mortgage points could easily outweigh the savings you’d actually ‘make’ by buying down your rate. So make sure you consider the amount of time you plan to keep your loan before deciding whether or not to pay for discount points. 

On a settlement statement, discount points are sometimes labeled “Discount Fee” or “Mortgage Rate Buydown.” They are different from “origination points” which are fees a bank charges to set up your loan.

Check your mortgage rates (Dec 5th, 2021)

How discount points affect your mortgage rate

When discount points are paid, the bank collects a one-time fee at closing in exchange for a lower interest rate for the life of the loan.

However, the size of your interest rate reduction will vary by bank.

This is one of the reasons why it’s important to shop for your best mortgage rate. Different banks will offer different sets of discounts in exchange for paying points.

As a rule of thumb, paying one discount point lowers a quoted mortgage rate by 25 basis points (0.25%). However, paying two discount points will not always lower your rate by 50 basis points (0.50%), as you would expect.

Nor will paying three discount points necessarily lower your rate by 75 basis points (0.75%).

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

  • 3.50% with 0 discount points. Monthly payment of $449.
  • 3.25% with 1 discount point. Monthly payment of $435. Upfront cost of $1,000
  • 3.00% with 2 discount points. Monthly payment of $422. Upfront cost of $2,000

Payment estimates do not include real estate property taxes or homeowners insurance. They include mortgage principal and interest only.

Because they provide a lower interest rate, discount points will lower your monthly mortgage payments for the life of the loan. However, you’d need time for your low rates to translate into real savings.

In addition, banks consider this payment to be “prepaid mortgage interest,” which is tax-deductible for eligible tax filers. So for some mortgage borrowers, there’s an added tax advantage to buying points.

However, you don’t pay for discount points to get the tax break. You pay to get the mortgage rate break.

Are mortgage discount points worth it?

In the above example, the mortgage applicant saves $14 per month for every $1,000 spent on mortgage points. To reclaim the full $1,000 cost of the points, the homebuyer would need to make 71 regular monthly payments. That would take almost six years.

Home finance experts call the time it takes to recover your upfront cost the “breakeven point.”  

Every mortgage loan will have its own breakeven point for buying points.

If you plan to stay in your home beyond the breakeven point and — this is key! — if you don’t think you’ll refinance before the breakeven hits, paying points may be a good idea.

The longer you stay in the home beyond the breakeven point, the more you’ll save because the interest rate reduction continues generating monthly savings as long as you have the loan.

Selling your home or refinancing the mortgage before its breakeven point can make discount points a waste of money. In this case, you’d do better to put the money toward your down payment to increase your home equity.

According to Freddie Mac, the typical 30-year fixed-rate mortgage loan carries between 0.5 and 0.7 discount points.

Adjustable-rate mortgages tend to carry fewer points because ARM homebuyers intend to sell or refinance sooner. Points pay off only if you keep the loan long enough to realize savings from the interest rate reduction.

How mortgage points affect APR

Banks will sometimes use a mortgage shopping tool known as “APR” to make a loan with discount points look more attractive than it really is.

APR, which stands for Annual Percentage Rate, is a calculation which is meant to show the long-term cost of holding a mortgage; and paying points lowers long-term costs in the form of a lower mortgage rate.

But APR also assumes you’ll hold your loan for 30 years. Very often, you will not, which nullifies the APR math.

This is why it’s important to remember that your APR is not your mortgage rate. Your mortgage rate is your mortgage rate.

Comparing loan estimates using the “lowest APR” method is rarely a good plan. It uses discount points against you.

If you’re not clear how much you’ll pay to borrow, ask your loan officer to walk you through your Loan Estimate or a truth-in-lending disclaimer.

“Negative” discount points (zero-closing cost loans)

Another helpful aspect of discount points is that lenders will sometimes offer them in reverse.

Instead of paying discount points in order to get access to lower mortgage rates, you can receive points from your lender and use the cash to pay for closing costs and fees associated with your home loan.

The technical term for reverse points is a “rebate.”

Mortgage applicants can typically receive up to 5 points in rebate. 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 with a 30-year loan term:

  • 3.50% with 0 discount points. Monthly payment of $449
  • 3.75% with 1 ‘negative’ discount point. Monthly payment of $463. Credit of $1,000 toward loan costs
  • 4.00% with 2 ‘negative’ discount points. Monthly payment of $477. Credit of $2,000 toward loan costs

Payment estimates do not include real estate property taxes or homeowners insurance. They include mortgage principal and interest only.

Homeowners can use rebates to pay for some, or all, of their loan’s closing costs. When you use a rebate to pay for all of your closing costs, it’s known as a zero-closing cost mortgage loan.

Zero-closing cost mortgages reduce the amount of cash required at your closing. The lender rebates can cover bank charges like origination fees along with closing costs charged by third parties.

Buyers who are using low-or no-down payment mortgages may find this option appealing — especially if they’re worried about keeping money in savings for emergencies or other life events.

When you do a zero-closing cost refinance, you can stay as liquid as possible with all of your cash in the bank.

Rebates can be good for refinancing, too.

Using rebates, a loan’s complete closing costs can be ‘waived,’ allowing the homeowner to refinance without increasing their mortgage amount.

When mortgage rates are falling, zero-closing cost mortgages are an excellent way to lower your rate without paying fees over and over again. You could potentially refinance three times in a year or more and never pay fees to the bank.

Are mortgage points tax-deductible?

Discount points can be tax-deductible, depending on which deductions you claim on your federal income taxes.

To write off discount points, or any other qualifying mortgage interest payments, you’d need to itemize your deductions using Schedule A of Form 1040.

If you take the standard deduction, you will not be able to deduct mortgage interest or mortgage points.

Discount points paid on a home purchase mortgage loan can be 100% deductible in the year in which they’re paid. Discount points on a home refinance mortgage loan cannot.

The tax deduction for points paid on a refinance loan is spread over the life of the loan. A homeowner paying points on a 30-year mortgage loan can claim 1/30 of the points paid as a deduction annually.

Always consult a professional before filing. This website doesn’t give tax advice. Let your tax preparer know if you’d like to write off mortgage interest payments and discount points.

What are today’s mortgage rates?

Today’s mortgage rates are at historic lows. Mortgage points allow borrowers to buy down their interest rate even further, which can generate huge savings.

However, mortgage points aren’t always worth it. And if you opt not to pay for them, you’re still likely to get a great deal in today’s ultra-low rate environment.

Verify your new rate (Dec 5th, 2021)