Discount Points

What Are Discount Points?

Discount points refer to an amount paid upfront by a mortgage borrower or home buyer to lower the amount of interest on future monthly payments.

They are purchased as one-time prepaid interests that help mortgage borrowers reduce repayments and interest. This can be by one-eights to one-quarter of a percent. The points are payable either when a mortgage is first arranged or when it is being refinanced.

They do not have out-of-pocket payments and can be merged with the loan balance or cleared by the seller.

It is a good option for borrowers who plan to hold on to the mortgage for an extended period but for one who expects to sell off the property or refinance before the maturity period of the loan, and it is less so.

Deeper Definition

A discount point is a kind of prepaid mortgage point that grants access to a borrower for discounted interest rates over the span of a loan.

It depends on the value of the borrowed money but generally costs 1% of the total loan amount. Each point reduces the interest on the loan by one-eighth to one-quarter of a percent.

Payments for discount points are often made at the start of the loan period, during the closing period. To prevent the borrower from having to make any payments, discount points and other closing points can be added to the new loan balance.

They are tax-deductible over the life of a loan, but they can be fully deductible for the year of payment if they meet specific requirements.

Most of the time, borrowers are made to pay discount points out of pocket. Still, some sellers volunteer to offset a specific dollar amount of the closing costs in certain situations, especially in buyers’ real estate markets.

The closing costs include the loan origination fee and title insurance charge. Failure to meet the threshold leads the seller to incorporate the discount points and lower the interest rate for free. 

Discount Points Example

If an individual decides to acquire a property and needs to loan $100,000 for that purpose, they may choose to get a mortgage for a standard period of 30 years. If the individual decides to pay three(3) discount points, that is, 3,000 dollars upfront, the interest rate reduces by about 0.5% This consequently reduces mortgage repayments.