How discount points really work, and the break-even nobody shows you

A discount point is a prepaid interest charge. One point equals one per cent of the loan amount, paid at closing, in exchange for a permanently lower note rate. It is the single most misunderstood line on a Loan Estimate, partly because lenders quote the rate loudly and the points quietly.

The arithmetic is not complicated. What makes it feel complicated is that the answer depends entirely on a number nobody can know for certain: how long you will keep this particular loan.

The grid, with real numbers

Take a $400,000 loan on a 30-year fixed. At par pricing the rate is 6.125% and the principal and interest payment is $2,430. Those are our current sample figures and every number below derives from them.

Half a point costs $2,000 and buys the rate to 6.000%, making the payment $2,398. That is $32 a month saved against $2,000 spent, which recovers in 62 months. One point costs $4,000 and buys 5.875%, a payment of $2,366, saving $64 a month. Also 62 months. Two points costs $8,000 and buys 5.625%, a payment of $2,302, saving $128 a month. Sixty-three months.

The consistency is not an accident. Lenders price the buydown curve so that the break-even lands in roughly the same place across the grid. If a quote shows one option with a dramatically shorter break-even than the others, look harder at the rate it is being measured against.

Sixty-two months is longer than it sounds

Five years and two months. That is how long you must hold this exact loan, at this exact rate, before a single point pays for itself. Not how long you stay in the house: how long you keep the loan.

Those are different things and the difference matters. If rates fall 0.750% in three years and you refinance, the remaining benefit of your buydown vanishes and the $4,000 stays spent. The median American mortgage does not survive to year seven. Ours are no different.

The question is not whether points are worth it. The question is whether this loan will still exist in five years.

When points genuinely make sense

• You are near the top of your comfortable payment and the lower payment is what makes the purchase work at all.
• You are buying at a moment when rates are historically low, making a future refinance unlikely.
• The seller is paying. A seller-paid buydown is other people's money and the break-even question changes completely.
• You are an investor on a DSCR file where a lower payment lifts the coverage ratio into a better pricing tier, which can be worth more than the points cost.

The opposite trade: taking a lender credit

Points run in both directions. Instead of paying $4,000 to drop your rate 0.250%, you can accept a rate 0.250% higher and receive roughly $4,000 as a lender credit toward closing costs. On our sample grid that is 6.375% with a payment of $2,495, sixty-five dollars a month more.

For a buyer who is short on cash to close, that is frequently the better transaction. Cash today has a use; sixty-five dollars a month is a rounding error against a transfer tax bill. In Philadelphia, where the combined transfer tax is 4.278% and the buyer's customary half on a $400,000 purchase is over $8,500, we write more lender credits than buydowns.

The credit also comes back to you faster than a buydown does. The break-even runs the other way: you have received $4,000 and you repay it at $65 a month, which takes 62 months. If you refinance in year three, you keep the difference.

How to compare two quotes properly

Ask every lender for the same thing: the rate at zero points, and the cost of each buydown step. A quote of 5.875% means nothing until you know whether it cost nothing or cost $4,000.

Then compare page two of the Loan Estimate, section A, which is origination charges. That is the lender's own fee. Our origination and underwriting is $1,095 flat, which is why we usually win on total cost at smaller loan amounts even when we do not win on the headline rate.

Finally, decide your holding period honestly, then compare the total cash outlay over that period rather than the monthly payment. A payment that is $32 lower is not a saving if it cost $2,000 and you sell in year three.