Discount points are points that the borrower offers to pay a lender as a method to reduce the interest rate on the loan, thus obtaining a lower monthly payment in exchange for this up-front payment.

Paying Points represent a calculated risk on the part of the buyer. There will be a specific point in the timeline of the loan where the money spent to buy down the interest rate will be equal to the money saved by making reduced loan payments resulting from the lower interest rate on the loan.

Selling the property or refinancing prior to this break-even point will result in a net financial loss for the buyer while keeping the loan for longer than this break-even point will result in a net financial savings for the buyer. The longer you keep the property financed under the loan with purchased points, the more the money spent on the points will pay off. If the intention is to buy and sell the property or re-finance in a rapid fashion, buying points is actually going to end up costing more than just paying the loan at the higher interest rate.

Example: If the rate without paying points was 6%, a loan of $100,000 fixed for 30 years costs $599.55 per month in principal & Interest. If paying 1.5 points reduces the rate by .5% the new payment is calculated using a 5.5% rate, or 567.79 per month.

Calculation for discount points:

Monthly Payment without Purchased Points - Monthly Payment with Purchased Points = Monthly Points Savings

Cost of Purchased Points / Monthly Points Savings = Number of Months to Break Even Point

Number of Months to Break Even Point / 12 = Number of Years to Break Even Point

The 5.5% rate costs $1,500 in points, and saves $31.76 / month. $1,500 / $31.76 = 47.23 months, or (divide by 12) 3.94 years. If you leave the house before 3.94 years, you wasted money