Many borrowers are confused by the idea of a discount point. A discount point is basically pre-paid interest that allows a borrower to lower their interest rate on the money they borrow for a mortgage. Because it is pre-paid interest, it is tax deductible in full in the year it is paid.
What Are Discount Points Used For?
Points are typically used to buy down the interest rate. For example, on a 30 Year fixed rate loan, if the going interest rate is 3.75%, a point might bring the rate down to 3.5%, with the benefits of a monthly reduced mortgage payment.
Points can work in reverse as well. Many times this is referred to as a lender-paid closing cost loan. The borrower pays a higher rate, so the lender can then sell that loan for more money, and the lender then makes the additional money available to the borrower for the closing costs.