Mortgage Discount Points Explained
Discount points are upfront fees paid to a lender at closing to buy down the interest rate on a mortgage. One point costs 1% of the loan amount and typically lowers the interest rate by 0.25% (25 basis points).
Paying points is essentially pre-paying interest. The financial decision depends on whether you plan to hold the loan long enough for the monthly savings to exceed the upfront cost.
Let's define the math:
$$\text{Points Cost \$} = \text{Loan Amount} \times \frac{\text{Points Cost \%}}{100}$$
$$\text{Monthly Savings} = \text{Monthly Payment}_{\text{Base}} - \text{Monthly Payment}_{\text{Discount}}$$
$$\text{Break-Even Time (Months)} = \frac{\text{Points Cost \$}}{\text{Monthly Savings}}$$
If you plan to sell the home or refinance the mortgage before the break-even month, paying points is a net financial loss. If you hold the mortgage past the break-even timeline, you save money over the life of the loan.