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Discount Points: Do They Ever Make Sense?

Posted on April 26 By Justin McHood

Many people when shopping for a mortgage ask me "does it make sense to pay discount points and buy that rate down even lower?" and recently, it seems to have been asked of me more often than I normally see that question. It seems kind of odd because rates are still bouncing around historic lows - but for some reason, people seem to be more interested than they usually are.

Should you pay discount points and buy your rate down even lower than rates are today?

It depends.

Discount Points - How They Work

Quite simply, discount points are paid up front by the borrower in exchange for a lower interest rate. Exactly how much you pay up front and how much lower the rate that you get is somewhat negotiable. I use “somewhat” because it really does depend on a number of factors - and the factors usually change all of the time… but in general, there is a simple rule-of-thumb to use when paying discount points.

Discount Points - A Simple Rule of Thumb

While not *exactly* accurate, the general rule of thumb is that for every 1% of the loan amount - or every 1 discount point that is paid up front, the rate will drop .25%.

So as an example, if you wanted to borrow $200,000 and the par rate for a 30 year fixed rate loan was 5%, in order to get it down to a 4.75% rate, it would cost roughly 1 discount point or $2,000 up front.

So using the example of a $200,000 loan, if you paid one discount point, here is what the math would look like:

$200,000 x 5% = $1,073.64 monthly payment

$200,000 x 4.75% = 1,043.29 monthly payment

Difference in monthly payment = $30.35 each month or $364.20/year

Break-even = around 6 years.

Discount Points - When They Make Sense

Getting out our common-sense-back-of-the-napkin-calculator, in the above example, you could argue that paying a discount point may make sense if you planned on having the loan longer than 6 years.

Generally speaking, the longer that you plan to have the loan, the more sense it may make to buy the rate down. If you are moving into the home of your dreams and planning on staying there for 30 years - then it may be a wise option to pay a discount point - or maybe even two!

Discount Points - How To Get Them Paid By Someone Else!

In today’s real estate market, I often see sellers willing to contribute money towards closing costs as an incentive for buyers. When negotiating the purchase of a home, it makes the absolute most sense of all if you can get the seller to pay a discount point to buy your rate down because it then effectively becomes “free” to you and it can help lower your mortgage payment by hundreds of dollars each year!

Whether or not you should pay a discount point is really a case by case situation. Because every lender’s rate sheets look different every day, the 1 discount point = .25% lower rate rule of thumb is helpful - but often times you can get even a much better deal than that. The key is to start the conversation with your loan officer by asking the question…

“Does it make any sense in my situation to pay a discount point?”

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