By Michelle Fields-Hall, Lender
When buying a home, there are many financing options out there, such as mortgage discount points (also known as points, discount points, or loan discounts). As a new buyer, what do you need to know?
What is a Mortgage Discount Point?
A point, or mortgage discount point, is a fee paid to the lender at the time of getting a loan and is used to lower your mortgage interest rate. Each point costs 1% of the loan amount. For example, a point on a $500,000 mortgage would cost $5,000.
Paying points can be a good way to lower monthly home payments to counteract higher interest rates and they have caught the attention of more homebuyers. A 2024 Consumer Financial Protection Bureau report found that as interest rates rose during the 2022 through 2023 inflation surge, more borrowers paid points when originating their mortgage loan.
How Do Points Work?
Interest rates are part of what determines how much money is due to the lender each pay period. The interest is part of your monthly mortgage payment, which also includes your principal, taxes, and insurance (Taxes and insurance are included if you pay them through an escrow account).
A discount point is a one-time fee paid to the lender to lower the interest rate on your mortgage. The more points you buy, the more you will lower your interest rate. The exact amount your interest rate will lower depends on the lender and market conditions. If you buy points, you are basically prepaying part of your interest ahead of time, so your monthly mortgage payment is less because the interest portion of your payment is less.
Who Should Use Mortgage Discount Points?
While buying points allows you to spend less money on your mortgage payment over time (the interest portion of the payment), it means you pay more money at closing. Homebuyers who are most likely to benefit from buying points are typically those with disposable income or those looking to purchase an investment property. So, if you have funds available, and increasing the upfront cost is not a major challenge for you, points can be a worthwhile investment.
However, for first time homebuyers or borrowers with less capital, you should talk to your lender about grant programs instead of mortgage discount points because grant programs can help eligible borrowers by lowering the initial costs and assisting with the down payment and closing costs. When considering a loan, make sure to ask your lender which options will best benefit you and come prepared for the conversation with the lender so you can get the best available loan possible. You can learn more about possible loan and grant options for you to discuss with your lender on the Maryland Home Loans webpage. For more information on types of lenders, read our blog!
Mortgage Discount Points: Pros and Cons
Discount points are paid at closing and are added to your closing costs.
The biggest advantage of buying points is you don’t have to pay as much for your monthly mortgage payment as you would otherwise because you paid the one-time fee for the point. A lower interest rate can save you money over the life of the loan if you keep the loan a long time. You may also be able to qualify for a larger mortgage with the help of points.
Mortgage points may also be tax deductible (You would need to consult with a tax professional to know when points are and are not tax deductible). So, if you have money available, plan on owning the property for a long time, and plan on keeping the same loan, increasing your out-of-pocket costs at the time of closing might be better in the long run compared to spreading the cost over time with a higher mortgage interest rate.
A disadvantage of using discount points is that if you sell your home or refinance your loan before the interest savings equal the cost of the points, you may lose money. Before you decide to pay for points, you should calculate your break-even point to determine if buying points will save you money. The break-even point is when the interest savings you receive equal the cost of the points. It’s also good to keep in mind that the more money you put down, the less money you have for emergencies or other things.
If you don’t have disposable income to justify spending more upfront closing costs, or you don’t plan on staying in the property or keeping the loan for a long time, then points may not be for you.
Important Considerations for Using Mortgage Discount Points
So before deciding whether to purchase mortgage points, be sure to do the math to decide if the difference is significant enough to justify the additional closing costs and to consider some additional factors:
- There are caps both on national and state levels for how many points can be bought.
- It is also worth noting that the amount your interest rate is reduced by for each point you buy depends on the lender, the type of loan, and the market conditions.
- Your monthly payment can increase because of other factors – like increases in taxes, insurance, if your loan is an adjustable-rate mortgage, etc.
