Discount points are a kind of prepaid interest that a borrower pays as an upfront fee to their lender at the time of closing. By paying discount points you pay more upfront, but receive a lower interest rate and therefore pay less over the life of the mortgage.
In general, one discount point costs 1% of the total loan amount – and paying it up front can reduce your interest rate (typically by 0.125% and 0.25%). So, for example, on a $100,000 loan with an available rate of 4.00%, one discount point would require $1,000 due at closing, but your interest rate would then be reduced (to between 3.75% and 3.875%) for the life of the mortgage.
Lenders benefit from discount points by receiving cash upfront instead of waiting for money in the form of interest payments over time. The exact amount that your interest rate is reduced depends on your lender, the type of loan, and current mortgage market conditions.
The longer you plan to stay in your home, the more sense discount points make. If you plan to relocate or refinance in the near future, paying discount points is probably not for you.
