Discount Points
A discount point is a fee equal to one percent of the loan amount, paid at closing to lower the interest rate on the mortgage. Points are a form of prepaid interest: the borrower pays more up front to reduce the cost of borrowing over the life of the loan. Two points on a $300,000 loan cost $6,000.
Discount points appear in the financing section of the national exam. They are tested as a simple calculation (points times loan amount), as a distinction between points and origination fees, and as a question about when points are tax deductible.
What a point actually is
A discount point is a one-time charge equal to one percent of the loan amount. Borrowers pay points at closing to buy a lower interest rate for the life of the loan, a transaction often called buying down the rate. Because the cost tracks the loan and not the property price, the first step in any points problem is to identify the amount borrowed.
Points are prepaid interest
Points are not a service charge or an application cost; they are interest paid in advance. The lender collects the money at closing and, in exchange, charges a lower rate on every future payment. That is why points live in the loan's finance charges: the borrower is effectively paying some of the interest up front to shrink the payments that follow.
Whether points are worth it comes down to time. A borrower who plans to stay in the home long enough for the monthly savings to exceed the up-front cost comes out ahead. A borrower who expects to sell or refinance quickly may pay for a benefit they never fully collect. The lender sets how much a point lowers the rate, so the savings per point is not a fixed universal number.
Points versus origination fees
These are two distinct charges, and the exam likes to list them side by side:
| Charge | What it pays for | How it is set |
|---|---|---|
| Discount points | Buying down the interest rate | A percentage of the loan amount, chosen by the borrower |
| Origination fee | The lender's cost of making the loan | A separate fee, also often a percentage of the loan |
Both can appear on the same settlement statement. A borrower might pay one point to lower the rate and a one-percent origination fee to cover the lender's work, two separate figures that draw from the same loan balance but do different jobs.
Tax treatment
Points paid on a mortgage used to buy a principal residence are generally deductible in the year they are paid, subject to IRS conditions. Points on a refinance are typically deducted over the life of the loan instead, and the rules for investment properties and second homes differ again. Tax law changes and individual situations vary, so the exam expects you to know that points are deductible on some loans and to recognize the purchase-versus-refinance distinction, not to memorize a single blanket rule.
A worked example
A borrower takes a $300,000 loan and agrees to pay 2.5 points to reduce the rate. One point is 1% of the loan, so 2.5 points is 2.5% of $300,000. The cost is $300,000 x 0.025 = $7,500, due at closing on top of the down payment and other fees. Had the same borrower paid two points on a $400,000 loan, the charge would be $400,000 x 0.02 = $8,000.
How it appears on the exam
Most points questions are arithmetic with a twist: the loan amount is buried in a sentence, and the distractors are the down payment, the price, or the total interest. Multiply the loan by the point percentage and you have the answer. The rest are concept questions asking what a point is (one percent of the loan), when it is paid (at closing, as prepaid interest), and how it relates to origination fees and taxes.
Memory trick
PAID
Points are money you pay now to change what you pay later. Remember P-A-I-D.
- P
Percentage of the loan: one point always equals one percent of the loan amount
- A
Advance payment: points are prepaid interest, paid in cash at closing rather than monthly
- I
Interest rate lowered: the purpose of paying points is to buy down the note rate
- D
Deductible: points are tax deductible on some purchase loans, subject to IRS rules
Screenshot this: PAID is how you'll remember discount points on exam day.
How the exam tricks you on this
The classic distractor is a point cost figured on the purchase price instead of the loan amount. A point is one percent of what the borrower borrows, not one percent of the home's price. On a $250,000 home with a $200,000 loan, two points cost $4,000 (2% of the loan), not $5,000 (2% of the price). Always grab the loan figure first.
Two more patterns to watch for:
- Discount points and origination fees are separate line items. An origination fee pays the lender for making the loan, while discount points specifically buy down the rate. They can both appear on the same settlement statement, so don't merge them into one number when a question lists them apart.
- Tax deductibility depends on the loan and the year. Points paid on a loan to buy a principal residence are generally deductible in the year paid, while points on a refinance are usually spread over the loan term. Rules differ for investment and second homes, so the safe exam answer is that points are deductible on some loans, not all.
Try real exam questions on discount points
These come straight from our question bank: answer to see the explanation instantly.
Maria borrows $600,000 and pays two points for the loan. How much does she pay in points?
Tip: press 1–4 to answer, Enter for the next question.
Related terms
Amortization
Amortization is the process of paying off a mortgage through scheduled periodic payments. Each payment covers interest on the current balance plus a portion of principal, and over the term the principal share grows while the interest share shrinks. A fully amortizing loan reaches a zero balance at the end of its term.
Read definitionLoan-to-Value Ratio
The loan-to-value ratio (LTV) is the loan amount divided by the property value, expressed as a percentage. It shows how much of the property the lender is financing and how much the borrower covers in cash. A $320,000 loan on a $400,000 home is an 80% LTV, with a 20% down payment.
Read definitionPITI
PITI stands for principal, interest, taxes, and insurance, the four parts of a typical monthly mortgage payment. Principal pays down the loan balance, interest is the cost of borrowing, taxes are property taxes collected for the county, and insurance covers hazard and, when required, mortgage insurance. Lenders use PITI to measure affordability.
Read definition
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