Understanding Mortgage Points

The term mortgage points, or discount points, refers to 1 percent increments of the total loan amount. Paying a point is like prepaying interest on your loan. This has the effect of reducing monthly mortgage payments.

Points Affect Payments

Generally speaking, paying 1 point, or 1 percent of your loan amount, will reduce your interest rate by approximately 1/4 to 1/8 of a percent. This means that you would need to pay 4 to 8 points to reduce your rate by a full percent, and 0 to 4 discount points is the norm. Since points are essentially interest payments, though, they are often tax-deductible.

Benefits

Paying a discount point on a $100,000 mortgage with an interest rate of 6 percent, would cost $1,000 at the time of closing. If the lender offers mortgage points for 1/4 of a percent, that will reduce the interest rate to only 5 3/4 percent, reducing payments by $16 per month. This means that in about 5 years, the cost of the point will be recovered, and savings will begin.

Disadvantages

The $1,000 paid in the above scenario may be more wisely invested elsewhere. It takes an average of 5 or more years to see true savings from buying discount points, and many homeowners plan to sell their home within that time period.  If you do not plan to stay in your home beyond the time that it takes to recoup the cost of the mortgage points, then a zero point loan is the best option.