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Colorado Mortgage Originator License: NMLS 460275 / 232720

Is it worth paying a discount point to obtain a lower rate?

The easiest way to answer this question is to calculate the "break even" point. Typically, paying a 1% discount point reduces the interest rate by .25% on a fixed rate mortgage. There is a point in time where you break even in terms of recouping the additional dollars spent upfront by saving money on a monthly basis with a lower rate and payment.

Example:
30 year fixed rate loan of $300,000 @ 4.0% = $1432/mo. principal & interest
30 year fixed rate loan of $300,000 @ 3.75% = $1389/mo. principal & interest

Paying a 1% discount point or origination fee to lower the rate to 3.75% reduces the monthly payment by $43 per month. However, the cost of the lower rate is $3000. The break even point is: $3000 divided by $43 = 70 months or 5.8 years. It will take over 5.8 years to recoup the additional money paid to obtain a lower rate.

If a borrower is planning on moving or refinancing in less than 5 years, it would be more cost effective to avoid the discount point or origination fee. If the perspective is longer term, the lower rate may be the best choice.

Things to consider:

  • The tax implications are different between a refinance and purchase transaction.
  • On a refinance, if the discount point is rolled into the new loan, the break even point is longer.
  • Paying a discount point on an ARM product may lower the rate more than .25%.