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A discount point is a one-time commission, equal to 1% of the loan amount, which is used to prepay part of the loan interest. For example, if the loan amount is $500,000, one discount point will be $5,000. The discount point fee is usually paid at closing.
When paid, the discount points reduce the interest rate, usually by 0.125% per point. The more points you pay, the lower will be the interest rate. Usually, you have the option to pay between zero and four points.
In the United States, the discount points fee is tax-deductible. However, tax deductibility can vary for purchase and refinance loans. With refinance, the points you pay are usually deductable over the whole term of the loan. With a purchase, they may be tax-deductible for the current year of the purchase.
Points or no points?
If you plan to stay in your new home for the long term, and you can afford one or more discount points, then go for it - you will benefit from reduced monthly mortgage payments in the long run. If you are planning to move out soon then keeping your money is a better option.
For example, let us compare two loans, one with no points and one with two points:
With the two discount points, your monthly saving is $27.84, which represents a total saving of $5011 over the whole term. It will take 143 months (about 12 years) before these savings become greater than the initial cost of the discount points and they start to be "profitable". Therefore, paying discount points is only worthwhile if you plan to stay in your new home for more than 12 years.