What is a Discount Point?

Recently, I have been asked a few times about “when is the right time to pay discount points to buy the rate down?” which I find odd considering that rates are at historic lows.  Regardless, I decided that there might be enough interest in the ins-and-outs of discount points that I would share some generic information about them.

Discount Points – What Is A “Discount Point”?

“Discount point” is a term to describe the amount of money that if you give a lender, they will in exchange “give” you a lower interest rate.  1 discount point = 1 percent of the loan amount. A bona-fide discount point is when the discount point actually “buys down” the rate.  It is possible to pay a discount point and not actually buy down the rate, so be sure to double-check that the discount point is actually being used to buy down the rate.

Discount Points – A Rule of Thumb

A good general rule of thumb is that each discount point will reduce the interest rate by about .25%.  So if you are offered a 5% rate with no discount points, you could reasonable expect the answer to the question of “what will my rate be if I pay 1 discount point?” to be 4.75%.  Again, this is just a rule of thumb, and it is not always the case.

As an illustration, if the par rate were 5% for a 30 year fixed rate mortgage on a $200,000 loan, if you wanted to get a 4.75% rate, it would cost roughly 1 discount point or $2,000.

Discount Points – When They Make Sense

Generally speaking, the longer that you intend to keep the loan, the more sense it may make to buy the rate down.  If you are moving into the home of your dreams and planning on staying there for 30 years – then it may be a wise option to pay a discount point – or maybe even two!

Using the above example $200,000 loan, if you paid one discount point, here is what the math would look like:

$200,000 x 5% = $1,073.64 monthly payment

Break-even = around 6 years.

So it would seem to make sense to pay a discount point and buy the rate down if you planned on having the loan longer than 6 years in this situation.

Discount Points – When They Make THE MOST Sense

One often overlooked item when negotiating for a new home is the fact that in a buyers market, you can often times get the seller to pay at least one discount point to buy your rate down! If you can possibly get the seller to pay a discount point to buy your rate down, this is when paying a discount point makes the most sense of all — it is “free” to you and it will help lower your mortgage payment by hundreds of dollars each year!

If you are in the process of getting a mortgage, be sure to ask your Realtor and mortgage professional if they think that it makes sense to pay discount points in your situation.  See if they know the “rule of thumb” where each discount point should reduce the rate by about .25%.  See if they “normally” try to negotiate for the seller to pay discount points if you are planning on being in the mortgage for a long period of time (if not, negotiate for other things for the seller to pay that will save you more money).

And what if when you ask about discount points, they look at you with a blank stare?

We would be happy to go over our-little-discount-point-secrets with them too.

Arizona Mortgage Rates for January 13, 2008