Discount Points

Author: Terri Ewing | Date: August 1, 2008 | Filed In: Glossary

Discount Points Defined

A discount point is defined as interest paid upfront in exchange for a lower rate calculated as a percentage of the loan amount.

A point is equal to 1 percent of the loan amount so 1 point would be 1%. A ball park estimate for how much of a drop in rate for each discount point paid is .25% in rate drop for each point paid. For example, 1 discount point could lower your rate from 6.25% to 6.00%. It would cost $3,000 on a $300,000 loan amount (1% X $300,000). Remember since discount points is defined as interest, it is usually the only cost paid at closing that is tax deductible.

Paying discount points is smart if you plan on being in the house for a long time. The way to figure out if a discount point makes sense is to do a little math. The principal and interest payment for the rate of 6.25% would be $1,847. The principal and interest payment for the rate of 6.0% would be $1,798. That is a difference of $49. It cost you $3,000 for the 6.0% rate so divide $3,000 by $49. You get 61. It will take you 61 months to recoup your $3,000 and start benefiting from the lower rate. If you plan on being in the home longer than 61 months, a discount point makes sense.

Just make sure you use a discount point the smart way. If the originator starts out with an inflated rate, then you did not pay a real discount point. If the rate was inflated, it wasn’t interest upfront it was money they were going to grab from you anyway. The best way to protect yourself from this is find a broker with access to a wholesale lender. Then make sure the discount point goes directly to the wholesale lender not the broker. A true discount point goes to the lender for actual interest and is the only way you’ll get the tax deduction.

To learn more about discount points read, 30 Year Mortgage Rate - Who Is Telling The Truth?

Author: Terri Ewing