Mortgage Discount Points: What They Are and How to Use Them

Whether you want to secure a first mortgage to purchase a home or refinance a current mortgage, you’re likely to come across the term “mortgage discount points” or “points” during the process.

In this post, we’ll not only describe the significance of mortgage discount points, but we’ll also walk you through how to use them, pay for them, and whether they are tax-deductible. At the end of the post, we’ll give you some pointers on how to decide if paying for mortgage discount points is right for you.

What Are Mortgage Discount Points?

The term “mortgage discount points” refers to the interest rate reduction a borrower receives from their lender when they pay for a portion of their mortgage interest charge upfront.

Mortgage discount points are an effective way to obtain a lower interest rate on your loan. By lowering your interest rate, you also lower your monthly payment and reduce the overall amount of interest you will pay for your home over the entire loan term.

Buying mortgage discount points can be a good idea if you’re arranging for a fixed-rate home mortgage with a loan term of 20 or 30 years and you plan to keep the loan for a long time, meaning you are not planning to refinance or sell the home in the near future.

Are There Benefits to Purchasing Discount Points?

Lenders find mortgage discount points attractive because they receive a portion of the interest payment upfront, which increases the lender’s liquidity and lowers the risk affiliated with the loan. Some borrowers prefer buying points because it lowers their monthly mortgage payment and the amount of total interest they will pay throughout the life of the loan. In a nutshell: It saves the buyer money over time.

How Do Mortgage Discount Points Work?

Mortgage discount points are calculated based on the amount of your home mortgage, and one point is equal to one percentage point of your loan amount. However, the discount points that you buy don’t have to be round numbers; instead, they can be fractions of a percent like 0.385%. It depends on the deal arranged with your chosen mortgage lender.

Discount point costs depend on the lender, the loan amount, the type of loan, and the overall mortgage market. Since lenders have different pricing structures, you’ll want to request loan estimates from different institutions while you’re looking for a home mortgage. Make sure to ask for the same loan amount and the same number of discount points from each lender so you have an apples-to-apples comparison. If one lender is offering better pricing for their discount points, show their offer to the other lenders to see if they can match it.

It’s important to note: The Consumer Financial Protection Bureau limits the total amount of upfront points and fees (not including the loan’s interest rate) that lenders can charge for qualified loans to 3% of the loan amount.

How Can I Pay for Mortgage Discount Points?

Mortgage discount points are purchased during the closing as a one-time payment. There are three ways you can pay for mortgage discount points:

1. Paying in cash at closing
2. Having the seller pay for them
3. Financing them by rolling the points into the loan amount.

For new loans, the borrower typically needs to pay for the mortgage discount points in cash or have the seller pay the cost at closing as part of their closing costs. If you are refinancing, the lender may be willing to roll the cost of the mortgage discount points into the new loan amount. Please note, if you choose to finance the mortgage discount points, you may not be allowed to include the mortgage discount points payment in your tax deductions (more on that below).

If you are paying for your mortgage discount points yourself, you will pay the cost at closing when you pay for your other closing costs. You will find the amount you owe for your mortgage discount points on your Loan Estimate and your Closing Disclosure, on page 2, in Section A. By law, this cost must be connected to a discounted interest rate.

Are Mortgage Discount Points Tax Deductible?

The IRS allows you to deduct the cost of your mortgage discount points as mortgage interest in the year you pay it, as long as your payment and the mortgage discount points themselves meet the following requirements:

• You itemize your deductions on a Schedule A, Form 1040.
• The points relate to a mortgage that is used to buy, build, or improve your principal residence.
• The mortgage is secured by your principal residence.
• It is an established business practice in the geographic area where the loan was made to pay for discount points.
• The amount you pay for mortgage discount points is not more than the amount generally charged for the same amount of discount points in the geographic area.
• You pay for the cost of the mortgage discount points out of your own funds during or before loan closing.
• The points you purchase have been computed as a percentage of the principal mortgage amount.
• The amount you pay shows clearly on your Settlement Statement as “points.”
• If your seller is paying for your mortgage discount points, you can deduct their payment from your taxes as long as you also deduct the amount they paid from your home’s purchase price.

The following closing costs are not deductible as mortgage interest:

• The cost to prepare the mortgage note
• Appraisal fees
• Notary fees
• Additional points the lender charges for other costs.

Sellers that pay for their buyer’s mortgage discount points can’t deduct the payment as mortgage interest from their taxes. But they can include the payment as a selling expense and deduct it from the gain on their sale.

Should I Take the Mortgage Discount Points?

If your chosen lender is offering mortgage discount points, here are some things to consider before taking them:

• Can you afford the upfront cash requirement?
• Are you satisfied with the market interest rate or do you want to create more room in your monthly budget?
• How much money will you save each month with the reduced interest rate?
• How much money will you save this tax year by deducting the upfront mortgage discount point payment from your income taxes?

As previously mentioned, you can also include any tax savings you will receive by deducting the cost of the mortgage discount points as mortgage interest. Then calculate how long you will stay in the home with the same home mortgage in order to recoup the upfront cost. Does this amount of time fit with your plans?

If you’re unsure whether it makes financial sense to take the mortgage discount points, you can reach out to a mortgage advisor. They can help walk you through your options and to make the best decision for your situation.

Are Lender Credits the Same Thing as Discount Points?

The simple answer is: No. In a way, they are the inverse of each other. Discount points exist to lower your mortgage interest rate – which is sometimes called “buying down the rate.” Lender credits work the opposite way. Instead of paying an upfront fee to bring the long-term interest rate down, homebuyers will take on a higher interest rate in exchange for lower upfront closing costs.

The Bottom Line

Mortgage discount points can be a good way to reduce the interest rate on your home mortgage, thus reducing your monthly mortgage payment and the total interest you pay over the course of your home loan. But you want to make sure you can afford the upfront cost and that your future plans will allow you to benefit from the reduced interest rate. If you have specific questions about mortgage discount points or shopping for home mortgages in general, reach out to a mortgage advisor today.