What Are Discount Points on a Mortgage?

When you are getting a mortgage loan, either for a purchase of a new home or refinance of an existing one, your mortgage lender will talk with you about your options of paying discount points. Since most of us do not go out and get a mortgage very frequently, some of the mortgage jargon can be confusing, including the term discount points. It is important that you understand the meaning of what discount points are since it can be an expensive mistake to either pay them or not pay them.

Discount points are also known as investor discount points, or more simply points. The first discount point paid on a loan is also commonly called an origination fee. Each discount point paid after that one-per cent is called a discount point.

The calculation for discount points is done by taking the percentage of points charged by the loan amount, paid as a one-time closing cost upon your loan closing. For example, if your loan is charging a 1 per cent discount point on a $100,000 mortgage loan, the fee you will be charged is $1,000. On that same example, if there is a 1 percent origination fee and a 1 percent discount point, the calculation is 2 percent of the $100,000 for a total of $2,000.

What Are Discount Points on a Mortgage

The amount of discount points charged will vary based upon the interest rate being offered. For example, while a rate of 6 percent might require a lender to charge the one percent origination fee, they might also offer you a rate of 5.75 percent for an additional charge of one percent in discount fees.

You should also understand that the amount of discount points required by the lender can vary every day as interest rates change.

Now the big question for you will be whether or not it is worth it to pay discount points, and if so, how many should you pay. The answer to this depends primarily upon how long you anticipate holding on to the mortgage loan.

Assume for the moment that you have found your dream home and that you plan on living in that home for fifteen years or longer. You have plenty of money in the bank. By paying an additional 2 discount points on a $100,000 loan you are saving $40 monthly.

Is this worth it for you? To calculate the value simply take the one-time charge of $2000 and divide it by the monthly savings of $40, arriving at 50 months to break even. In other words, it will take 50 months for your monthly savings of $40 to recoup the $2000 you have invested. After that period of time your investment is now saving you $40 monthly over the remaining term of the loan.

So how long are planning on holding on to the mortgage? If you plan on paying it off or refinancing it within those 50 months, this will become a bad investment. However, if you are staying in the home and holding on to the mortgage for at least 10 years, your investment could pay off handsomely.

In general, discount points are usually a poor idea if your plan is to buy a home for a relatively short stay. If you are buying your home with long term intentions, electing to pay points might be an investment worth considering. Talk with your mortgage lender and tax accountant for their advice prior to paying discount points on your mortgage loan.

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