What is the purpose of discount points in a mortgage?

The purpose of discount points in a mortgage is to increase the lender's yield on the mortgage. When a borrower pays discount points, they are essentially pre-paying a portion of the interest on the loan at closing. Each point typically equals 1% of the total loan amount and can lower the interest rate charged on the mortgage. This means that while the borrower spends more initially (through the payment of discount points), it leads to a lower interest rate on the mortgage throughout its term, thus enhancing the lender’s return on the loan through these upfront payments.

The practice of using discount points is a strategic decision for borrowers who plan to stay in their homes for a longer period, as the lower rate will save them money over time. Initially paying more can translate into significant long-term benefits in terms of reduced interest payments, aligning the interests of borrowers and lenders in a mutually beneficial arrangement.