What are discount points on a loan?

No points ban symbolWhen I was originating mortgages, my customers would often tell me that they didn't want to pay points. I usually asked them if they knew what points are. Their response was typically 'no', but they did know that points were an additional expense. So what are discount points?

Discount points are prepaid interest. If you are willing to prepay some of the loan interest at settlement, the lender is able to reduce your interest rate.

Here's an example. Let's assume the loan amount is $100,000 with an interest rate of 4%. The total amount of interest paid over a 30-year term is $71,869.51 with a monthly payment of $ 477.42 (principal and interest).

Now let's take a look at the loan with one discount point. One discount point is 1% of the mortgage amount ($100,00 X 1% = $1,000) and one point reduces the overall interest rate by about 1/4%.

If you are willing to pay one point under this example, the total interest paid over the life of the loan would be $66,721.61 and the monthly payment would be $ 463.12 .

How much would this borrower save by paying one discount point?

Loan Amount Interest Rate Total Interest Monthly Payment
$100,000 4.00% $71,869.51 $477.42
One Point 3.75% $66,721.61 $463.12
Difference 0.25% $5,147.90 $14.30

From this example, the borrower pays an additional point ($1,000) at settlement, but reduces the total amount of interest by $5,147.90 and lowers the monthly loan payment by $14.30.

Frequently asked questions about mortage points

Q. Can I roll points into my refinance?
A. Points can be rolled into the new loan with most refinance loans, howerver, keep in mind that by including the mortgage points into the new loan, you are increasing the loan balance.

Q. Do you have to pay mortgage points out of pocket?
A. On purchase transactions, discount points are usually paid by the buyer however, the discount poins may be paid by the seller, provided the cost of the points meet the seller paid cloing cost limits.

Q. How are loan discount points calculated?
A. Multipy the loan amount by the discount point percentage.

Q. How many discount points can you buy?
A. Lenders will offer three discount points. Beyond three points, the savings begins to fall off.