Oct. 4, 2008 - About Loan Discount Points

Understanding Loan Discount Points

The term "loan discount points" is somewhat misleading. First off, there's no discount involved. Secondly, it's not about points, it's about dollars.

Loan discount points are a one-time fee charged by the lender at closing in order to give you a lower interest rate on your loan. Each point is 1 percent of the mortgage amount; for example, one discount point on a $100,000 loan equals $1,000.

Each discount point paid on a 30-year loan typically lowers the interest rate by 0.125 percent. That means a 7.5 percent rate would be lowered to 7.375 percent if you purchase one point. Paying for points lowers your interest rate because the lender receives the income in a lump sum at closing rather than collecting the interest as you make payments.

Buying points to lower your interest rate is not always a good idea. While buying points is sometimes a good decision, many times the purchase costs you more than it saves. It's very important that you analyze the costs to figure out how many years you need to keep the loan to break-even on paying points. Sometimes it takes 10+ years to reach the break-even point. Do you plan to live there that long?