Discount points are a one-time fee paid at closing to a lender in exchange for a lower interest rate. Put more simply, it is a one-time fee that you pay up-front to “buy” a lower interest rate for your mortgage. During periods of high interest rates, they are a popular way for borrowers to make their monthly payments lower.
Some things to know:
- One “discount point” is equal to one percent of the loan amount (i.e. a 1 point discount fee on a $100,000 mortgage is $1,000).
- The amount that a discount point decreases a mortgage rate by is NOT fixed (e.g. for 1 discount point, one lender may reduce the mortgage rate by 0.5% while another may reduce the mortgage rate by 0.25%).
- Discount points are often paid by the borrower, but they can be paid by others (e.g. a home seller or developer looking for creative ways to make their property more appealing to buyers).
- The “break-even period” is how long a borrower must keep their mortgage in order for the savings from the lower mortgage rate to outweigh the upfront cost of the discount point(s). It can be calculated by dividing the cost of the discount points by the monthly savings.
According to a report by the Consumer Financial Protection Bureau, in 2023, most consumers who got a mortgage in the first three quarters of 2023 paid some amount of discount points. Discount points were most common with cash-out refinances (88.5% of those borrowers paid discount points). 58.7% of home purchase borrowers and 56.2% of non-cash-out refinance borrowers paid discount points.
How many discount points did those borrowers pay? The median amount for cash-out refinance borrowers was 2.1 points, non-cash-out refinance borrowers was 1.1 points and home purchase borrowers was 1.0 points.
We are in a period where interest rates have recently fallen and the hope/expectation is that they will continue falling. However, discount points are still important to know about and understand:
- Often, an advertised mortgage rate has discount points baked in, which is one of the reasons to pay attention to the loan’s APR rather than just the mortgage rate.
- Requesting that a seller pay discount points is a potential negotiation tactic for buyers. For example, a developer that has several units in a new development to sell may be more firm on their sale price because it may impact the sales of the remaining units but may be willing to contribute towards discount points to reduce the buyer’s monthly mortgage payment.
As a final note, this information is provided solely for informational purposes. It is important for you to discuss your personal financial situation with a reputable bank or other lender. Please do not hesitate to reach out to us with any questions.
Data Source for this Post: Data Spotlight: Trends in discount points amid rising interest rates, Consumer Financial Protection Bureau, April 5, 2024