Discount points are a fee you pay at closing to buy a lower interest rate for the life of the loan. One point costs 1% of the loan amount, so on a $300,000 loan a point is $3,000. Points can come in fractions, such as half a point, and how much each point lowers the rate depends on the lender, the loan program and pricing on the day you lock.
What a point costs
| Loan amount | 1 point | 0.5 point |
|---|---|---|
| $250,000 | $2,500 | $1,250 |
| $300,000 | $3,000 | $1,500 |
| $400,000 | $4,000 | $2,000 |
Lender credits run the other direction. You accept a slightly higher rate, and the lender pays part of your closing costs. A buyer who is short on cash for closing usually comes out ahead with a credit, and a buyer with cash to spare who plans to stay put often comes out ahead with points.
The break-even math
As an illustration, suppose one point on a $300,000 loan lowers the rate from 5.75% to 5.50%.
- Principal and interest at 5.75%: $1,750.72
- Principal and interest at 5.50%: $1,703.37
- Monthly savings: $47.35
- Time to earn back $3,000: $3,000 ÷ $47.35 = about 63 months, or 5 years and 3 months
Keep the loan longer than that and the point has paid for itself. Over the full 30 years, $47.35 a month adds up to $17,046.
A point also lowers the payment the lender uses to qualify you. At FHA's 46.9% housing ratio, a $47.35 lower payment cuts the gross income needed by about $101 a month, which can be enough for a buyer sitting right at the line.
Who can pay for points
- FHA: the seller can pay points within the 6% of price concession limit.
- VA: the seller can pay normal closing costs and discount points, plus up to 4% of the reasonable value in other concessions. On a VA purchase, the funding fee can be financed but points can't be added to the loan.
- Conventional: points count toward the seller contribution cap of 3% with less than 10% down, 6% with 10% up to 25% down, and 9% with 25% or more down.
- USDA: the seller can pay points within the 6% limit.
When a seller offers a credit larger than your closing costs, putting the extra toward points lowers the payment for the life of the loan instead of leaving money unused.
Use the cash to close calculator to see how far a seller credit stretches across closing costs and points. Call AAA Capital Funding at 888-601-8344 for your rate at zero, one and two points on the same day's pricing.