When you’re buying a home or refinancing your mortgage, one option that might come up is paying “discount points” to lower your interest rate. But what are discount points, and why would paying them make sense? While not every borrower will benefit from paying points, for the right person, they can result in significant long-term savings. Here’s what you need to know.

What Are Discount Points?

Discount points are essentially a way to “buy down” the interest rate on your mortgage. Each point typically costs 1% of your total loan amount and reduces your interest rate by a set percentage, often around 0.25%. For example, if you’re borrowing $300,000, one discount point would cost $3,000. In exchange, your lender would lower your mortgage rate by 0.25% (for example, from 6% to 5.75%).

The decision to pay for discount points comes down to weighing the upfront cost against the long-term savings from a lower interest rate.

Why Paying Discount Points Could Be a Good Idea

Lower Monthly Payments The primary benefit of paying discount points is that it reduces your monthly mortgage payment. With a lower interest rate, you’ll pay less in interest over time, leading to smaller payments each month. For example, on a $300,000 loan with a 30-year term, lowering your rate by 0.25% could save you around $40-$60 a month, depending on the loan terms.

While this might not seem like a lot initially, those savings add up over the life of your loan.

Long-Term Interest Savings Over the course of a 30-year mortgage, even a small reduction in your interest rate can result in significant savings. For example, if paying $3,000 upfront in discount points saves you $15,000 in interest over the life of the loan, that’s a solid return on your investment.

The longer you stay in the home and keep the loan, the more advantageous paying points becomes. This is especially true if you’re planning to hold onto your home for many years or keep the same mortgage for a long time.

Beat Rising Interest Rates If interest rates are rising, paying discount points to lock in a lower rate can be a smart way to future-proof your finances. Even though it means more upfront cost, it helps protect you from potential rate hikes. In a market where rates are volatile, locking in a lower rate by paying points could save you from higher payments in the future.

Tax Deductions Discount points may be tax-deductible, which can sweeten the deal for many homeowners. In the year you purchase your home, the IRS typically allows you to deduct the full amount of the points paid, as long as certain requirements are met. If you refinance, you may still be able to deduct points, but the deduction might be spread out over the life of the loan. Always consult a tax professional to understand the exact benefits in your situation.

Helps With Refinancing Goals If you’re refinancing and plan to stay in your home long-term, paying points could make sense. A lower interest rate will reduce your monthly payment and may help you achieve your financial goals faster, like paying off your mortgage earlier or saving for other investments. Plus, if you already have significant equity in your home, the upfront cost of paying points might be more manageable.

Who Benefits Most From Paying Discount Points?

Long-Term Homeowners If you plan to stay in your home for many years, paying points is generally a good idea. The upfront cost will pay for itself in the form of lower monthly payments and long-term interest savings. If you’re unsure how long you’ll be in the home, calculate your “break-even point”—the number of months it takes for your monthly savings to exceed the upfront cost of the points. The longer you stay past this point, the more you benefit.

Borrowers Looking for Stability If you prefer the stability of a low fixed-rate mortgage and don’t want to worry about potential rate increases, paying points to lower your rate can give you peace of mind. This is especially true if you’re locking in a mortgage during a time of rising interest rates.

Buyers With Extra Cash on Hand If you have enough cash saved up, paying points can be an effective use of extra funds, especially if you’re already set with your down payment and emergency savings. The long-term savings on interest can offer a better return than many short-term investments.

High Earners Seeking Tax Deductions If you’re in a higher tax bracket, the potential deduction for paying points could be a helpful way to reduce your taxable income. This is particularly valuable for first-time buyers who may already have significant expenses and could benefit from additional deductions.

When It Might Not Be Worth It

While paying discount points can be beneficial, it isn’t for everyone. If you plan to sell or refinance your home in the near future, the upfront cost of points might not be worth the long-term savings, as you may not hold the loan long enough to reach the break-even point. Also, if cash is tight, you may be better off using those funds for your down payment or other expenses.

Conclusion

Paying discount points can be a smart financial move for homeowners who are looking to lower their interest rate and monthly payments over the long term. While there’s an upfront cost involved, the potential savings in interest can more than make up for it, especially if you plan to stay in your home for many years. Before making a decision, it’s essential to weigh your current financial situation, future plans, and how long you intend to keep your mortgage. For many, the long-term benefits of paying discount points can make it a worthwhile investment.