1. What are Discount Points and Lender Credits?
Discount points, often referred to simply as points, are prepaid interest that you can purchase from your lender at closing. In exchange for paying this interest upfront, the lender permanently lowers your mortgage interest rate.
One point costs exactly 1% of the total mortgage amount. Lenders also offer lender credits, which function in reverse: the lender pays a portion of your closing costs upfront in exchange for charging a higher ongoing interest rate.
2. Calculating the Point Buy-Down Break-Even Month
To determine if buying points is a sound financial decision, calculate your break-even month. Divide the upfront cost of the points by the monthly payment savings generated by the lower interest rate.
If purchasing one point costs $3,000 and reduces your monthly payment by $50, your break-even period is 60 months. If you sell the home or refinance the mortgage before month 60, you will lose money on the points.
3. Homeownership Horizon and Opportunity Cost
Your planned homeownership horizon is the most critical variable when deciding to purchase points. If you plan to live in the home for 10 or 20 years, buying points will yield significant long-term interest savings.
However, consider the opportunity cost. If paying for points depletes your cash reserves, leaving you with minimal post-closing liquidity, it is wiser to keep the cash. Compare the rate of return from buying points against low-risk investment options.
4. Tax Deductibility of Discount Points
Under IRS guidelines, discount points paid on a primary home purchase are generally tax-deductible as mortgage interest in the tax year they are paid, provided they meet standard criteria.
If you are refinancing, points must be deducted over the life of the loan rather than all at once. Because tax regulations are complex, consult a qualified Certified Public Accountant (CPA) to confirm your eligibility for mortgage point deductions.