When you compare loan offers, you will see rates paired with points or credits, and the pairings can make two offers hard to compare. The concept behind them is simple once it is spelled out. Both are a trade between money paid at closing and the interest rate you pay over the life of the loan.
Discount points
A discount point is a fee paid at closing in exchange for a lower interest rate. One point equals one percent of the loan amount. Paying points lowers your monthly payment for as long as you hold the loan. Lenders typically offer rates at several price levels: a rate with no points, a lower rate with some points, and a still lower rate with more. The amount a point lowers the rate varies by lender and by market conditions.
Lender credits
A lender credit is the same trade in reverse. You accept a somewhat higher interest rate, and in exchange the lender pays part of your closing costs. This can reduce the cash you need at closing, at the cost of a higher payment over time. Lender credits are sometimes offered as a way to help buyers who have a down payment but limited funds for closing.
Where you see them
On the Loan Estimate, points appear in the section for origination charges, listed as a percentage and a dollar amount. Lender credits appear in the summary of costs as a negative number that offsets other charges. The Closing Disclosure shows the final figures. If something is labeled as points, you can ask the lender to confirm that it is a discount point tied to a lower rate rather than a separate fee with a confusing name.
The break-even way of thinking
People often evaluate points by asking how long it would take for the monthly savings from the lower rate to add up to the amount paid upfront. That is the break-even period. If you expect to keep the loan well past that point, paying points may be worth considering; if you expect to sell or refinance sooner, it may not. The same logic runs in reverse for credits: a credit helps most when you expect to hold the loan for a shorter time.
This is a judgment about your plans and your finances, not a rule. The future is uncertain, and the right answer depends on your cash on hand, how long you expect to own the home, and your other priorities for that money. A financial advisor can help you think it through; your loan officer can show you the exact figures for each option.
Questions to ask
- What rate can I get with no points, and what does each additional point buy?
- What lender credit is available, and at what rate?
- Are any charges on this estimate points, and are they optional?
- Can you show the total cost of each option over several time horizons?
Ask for each option in writing so you can compare them side by side. Points and credits are tools, and the best use of a tool depends on the job. Knowing how they work lets you choose on purpose rather than by default.
A Worked Example of Break-Even Math
Numbers make the idea easier to see. The figures below are purely illustrative, not quotes or current rates, but the math works the same way with real numbers from your lender.
Imagine a loan of $200,000. One point would cost 1 percent, or $2,000, at closing. Suppose that paying that point lowers the monthly principal and interest payment by $30. To find the break-even point, divide the upfront cost by the monthly savings:
$2,000 ÷ $30 per month ≈ 67 months, or a little over five and a half years.
If you expect to keep the loan longer than that, the point may pay for itself. If you think you will sell or refinance within a few years, the upfront cost may not be recovered. Running the same calculation with the actual figures your lender provides gives you a clear, personal answer.
A lender credit works the same way in reverse. If accepting a slightly higher rate gives you a credit toward closing costs, you can compare the credit to the added monthly cost to see how long it would take for the higher payments to equal the credit you received.
How Points and Credits Fit Into an Offer
Points and credits come from the lender, but they interact with the rest of the purchase in a few ways:
- Seller concessions. In some purchases, the seller agrees to contribute toward the buyer’s closing costs. Depending on the loan program, those funds may be usable to pay for points. Program limits apply, so check with your lender.
- Cash to close. Paying points increases the cash you need at closing, which can affect how much remains for reserves, moving and early repairs.
- Offer strategy. In a competitive situation, asking the seller for concessions may make an offer less attractive. Your agent can help you weigh that tradeoff.
Mistakes to Avoid
- Comparing rates without comparing costs. A lower rate with several points is not directly comparable to a higher rate with no points. Compare total costs over the time you expect to keep the loan.
- Draining reserves to buy down the rate. New homeowners often face unexpected expenses. Keeping a cushion may be more valuable than a slightly lower payment.
- Ignoring your likely timeline. If a job change, a growing family or a planned move might shorten your stay, factor that into the decision.
- Not asking for options in writing. Verbal quotes are easy to misremember. Request written estimates for each option.
Quick Answers About Points and Credits
Are points the same as origination fees?
Not necessarily. Origination fees cover the lender’s cost of making the loan. Discount points are specifically tied to lowering the rate. Ask the lender to clarify which is which on your estimate.
Can I pay partial points?
Many lenders offer pricing in fractions of a point. Ask to see several levels side by side, since the best fit is sometimes in between no points and a full point.
Are points tax deductible?
That depends on your circumstances and current tax rules. A CPA or tax professional can tell you how they apply to your situation.
