EXPLAINING DISCOUNT POINTS
By Jessica Hudson | June 1, 2022
Mortgage points or “discount points” allow you to pay more in closing costs in exchange for a lower mortgage rate. That means you’ll have a bigger upfront fee, but a lower monthly payment over the life of the loan. One mortgage point costs 1% of the loan amount, and typically lowers your interest rate by .25%. So, for example, if your $200,000 home loan is quoted at a 4% mortgage rate, you might buy one discount point at $2,000 to get a 3.75% interest rate instead.
On a settlement statement, discount points are usually called “Points” or sometimes labeled as “Discount Fee” or “Mortgage Rate Buydown”. Discount points are fees specifically used to buy-down your rate. This makes them different from “Origination Points”, which are fees that a lender charges to “do your loan” (i.e. for processing, underwriting, etc.).
Are Mortgage Points Tax-Deductible?
The IRS considers discount points to be prepaid mortgage interest, so discount points can be tax-deductible, depending on whether you itemize or not.
Discount points paid on a home purchase mortgage loan can be 100% deductible in the year in which they’re paid. Discount points on a home refinance mortgage loan cannot. The tax deduction for points paid on a refinance loan is spread over the life of the loan. A homeowner paying points on a 30-year mortgage loan can claim 1/30 of the points paid as deduction annually.
Does Paying Points Make Sense?
You will want to have your lender determine the “break-even point” on paying points. For example, on a $100,000 mortgage, 3.5% with 0 discount points has a monthly principal and interest payment of $449, 3.25% with 1 discount point has a monthly principal and interest payment of $435 with a fee of $1,000. In this example, the mortgage applicant saves $14 per month with the discounted rate. This creates a “break-even point” of 71 months. If you plan to stay in your home beyond the break-even AND you don’t think you’ll refinance before the break even hits, paying points may be a good idea.
*It is important to note that in this current lending climate, there might be instances where there are no rates available for a certain product/loan scenario without paying points.
“Negative” Discount Point Loans (Zero-Closing Cost)
Another aspect of discount points is that lenders often offer them in reverse. The technical term for reverse points in rebate. Instead of paying discount points in order to get access to lower mortgage rates, you can receive points from your lender and use those monies to pay for closing costs and fees associated with your home loan. Homeowners can use rebates to pay for some, or all, of their closing costs. When you use a rebate to pay for all of your closings costs, it’s known as a “zero-closing costs mortgage loan”. This is very appealing to on purchase loans, when cash might be needed for other things such as a down payment, moving expenses, etc. Rebates often make sense on refinances as well when you do not want to bring cash to close or increase the size of your loan.