What are Discount Points?
Discount points are a form of prepaid interest paid at closing to reduce ("buy down") the interest rate on a mortgage. Each discount point costs 1% of the loan amount and typically reduces the rate by approximately 0.25%. Unlike origination fees, discount points are optional and represent a trade-off between upfront cost and long-term savings through a lower monthly payment.
On a $300,000 loan, one discount point costs $3,000 and might reduce the rate from 7.0% to 6.75%. This decreases the monthly payment by about $50. The break-even point (when cumulative savings exceed the upfront cost) is approximately 60 months. After that, the savings continue for the remaining loan term.
The break-even calculation
Break-even = Cost of Points / Monthly Savings. If one point costs $3,000 and saves $50/month, break-even is 60 months (5 years). If you hold the property and keep the mortgage for 10 years, the total savings are $6,000 ($50 x 120 months) minus the $3,000 cost, netting $3,000 in savings. If you sell or refinance before break-even, you lost money on the points.
Tax deductibility
Discount points are tax-deductible as prepaid mortgage interest. On a purchase, they can typically be deducted in the year paid. On a refinance, they are generally deducted ratably over the loan term. This tax deduction shortens the effective break-even period. Consult a tax professional for your specific situation.
Discount points and investors
For buy-and-hold investors planning to keep a rental property for 10+ years, discount points can meaningfully improve returns by reducing the interest rate and increasing monthly cash flow. For flippers using short-term financing, discount points almost never make sense because the holding period is too short to reach break-even. Always run the break-even calculation for your specific scenario before paying points.