Mortgage jargon often feels overwhelming, especially when you’re navigating terms like “discount points.” Understanding how prepaid interest works can save buyers and investors thousands over a loan’s life. This guide breaks down what discount points are, how they influence costs, and whether they’re right for your real estate strategy.
Discount points, also called mortgage points, are prepaid interest you pay at closing to reduce your loan’s interest rate. One point equals 1% of the loan amount (for example, $3,000 on a $300,000 mortgage) and typically lowers your rate by about 0.125%–0.25% per point.
These terms often get mixed up:
As a rule of thumb, each discount point reduces your interest rate by about 0.25%, though some lenders offer as little as 0.125% per point. Always compare offers to see each lender’s exact buydown.
Lower rates translate to smaller monthly payments and significant savings over the life of the loan. For a 30-year mortgage, even a 0.25% rate reduction can cut thousands off total interest.
Paying points increases your closing costs. One point on a $300,000 loan costs $3,000 in cash at closing, so plan your budget accordingly.
Cost: 1% of $300,000 = $3,000 upfront. Rate drop: from 4.5% to ~4.25%. Monthly payment saving: about $43 on principal and interest.
Over 15 years: ~$7,740 saved. Over 20 years: ~$10,300 saved. Over 30 years: ~$15,480 saved (estimates vary by lender and loan specifics).
Lenders typically cap discount points at 3–3.5 points. Buying more than that offers diminishing returns and rare rate reductions.
The break-even period is how long it takes for monthly savings to cover your upfront cost.
Months to breakeven = Cost of points ÷ Monthly savings. Example: $3,000 ÷ $43 ≈ 70 months (about 5.8 years).
Higher loan amounts, bigger rate reductions, and longer holding periods shorten breakeven. Selling or refinancing early before breakeven means a net loss.
Points on a purchase of a primary residence are generally fully deductible in the year paid if you itemize deductions. For refinances, IRS rules require you to deduct points over the life of the loan.
You must pay points to your lender, and the mortgage must secure your main home. Points paid by sellers or rolled into your loan are not deductible upfront.
Keep your Closing Disclosure, HUD-1, or lender statements showing the point amount. Save tax records for at least three years.
Temporary buydowns (e.g., a 2-1 buydown) lower rates briefly but revert later. Paying points buys a permanent rate reduction.
With an ARM, initial rates may be low enough that buying points is less beneficial.
Skipping points and investing your cash elsewhere can yield higher returns, depending on market performance.
A buyer pays 2 points ($6,000 on a $300,000 loan) to shave 0.5% off her rate, saving $90/month and breaking even in 67 months.
An investor buys 1.5 points ($4,500 on a $300,000 loan) to cut his rate 0.375%, lowers payments by $65/month, and reaches breakeven at about 69 months—just under his 7-year target.
Discount points prepay interest for a lower rate; origination points are fees for processing your loan application.
You can, but you pay interest on those points over the loan’s life, which often negates the upfront savings.
It depends on your budget, how long you’ll keep the loan, and your break-even analysis. Commonly, borrowers limit purchases to 1–2 points.
Probably not. If you won’t reach breakeven before selling or refinancing, upfront costs outweigh savings.
Not always. They’re deductible on a primary purchase but spread out over time for refinances and subject to IRS rules.
Paying discount points makes sense if you plan to hold your mortgage past the break-even period and want lower long-term interest. Run a personalized break-even calculation, compare lender offers, and discuss options with your lender or financial advisor to find the right strategy for your goals.
