﻿ What are discount points on a loan?

# What are discount points on a loan? When 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.