What are discount points?

Discount points are a form of prepaid interest that borrowers pay at closing to lower their mortgage interest rate. By paying these points upfront, borrowers can effectively reduce their monthly payments over the life of the loan. Each point typically costs 1% of the total loan amount and lowers the interest rate by a fixed percentage, often around 0.25%, although this can vary by lender.

This concept is crucial for borrowers to understand because it allows them to make a strategic decision based on their financial situation, such as how long they expect to stay in their home. If a borrower plans to stay in their property long enough, the reduction in monthly payments may outweigh the initial cost of the points.

The other options, while related to mortgage costs, do not accurately define discount points. Payments to the lender to reduce closing costs do not specifically relate to interest rates, and points deducted from the loan amount refers to a different financial aspect. Additional fees for processing an application are not linked to the concept of discount points. Hence, understanding the role of discount points helps borrowers make informed decisions regarding their mortgage financing.