Discount Points And The Break-Even Month

A discount point is not a fee for a service. It is interest, paid at the start rather than over time, in exchange for a lower rate across the life of the loan. Because it is a straight exchange of money now for money later, it has a break-even, and that break-even can be calculated in about a minute.

That makes points the most tractable line on a closing statement. It also makes them the line most often mis-compared, because a rate quoted with points and a rate quoted without them are not the same kind of number and cannot be ranked against each other.

The calculation

Take the cost of the points as shown in origination charges. Take the reduction in the monthly payment that buying them produces — the difference between the two payment quotes, not an estimate. Divide the first by the second. The result is the number of months of lower payments required to recover the cash you handed over at closing.

Worked example, assumptions stated. Assume a closed-end home equity loan. Assume the lender quotes two versions: one at rate R with no points, one at a lower rate costing 2,400 at closing, and assume the lower rate reduces the monthly payment by 40. These figures are illustrative and are not observed market levels; no lender, product or jurisdiction is implied. Then 2,400 ÷ 40 = 60 months. You reach break-even five years in. Every month after that is benefit; every month before it, you are behind.

Now stress the assumption that matters. If you expect to sell in four years, you will not reach month 60 and the points were a loss. If you expect to hold the loan to maturity, you will pass 60 by a wide margin and the trade was good. Nothing about the lender changed between those two conclusions. Only you did.

Refinements worth making, and one worth ignoring

The simple division above ignores three things.

Tax treatment. Points on some home-secured borrowing may be deductible, sometimes in the year paid and sometimes ratably over the loan term, depending on the loan's purpose, the taxpayer's position and current law. This materially changes the after-tax break-even for some borrowers and not at all for others. It is genuinely a question for a tax professional, and any article that gave you a rule here would be inventing one.

Opportunity cost. The cash you hand over at closing could have done something else — reduced the principal, sat in an interest-bearing account, or paid down a more expensive debt. A break-even that ignores this is optimistic. Comparing the points against simply borrowing less is often the more revealing exercise.

Amortisation. Early payments are interest-heavy, so a lower rate also shifts marginally more of each payment to principal. This works slightly in favour of points and is usually small enough to leave out of a first pass.

The refinement not worth making is precision beyond your confidence in the holding period. If your break-even lands at 58 months and your honest estimate of how long you will keep the loan is somewhere between four and eight years, no amount of decimal places will resolve that. The answer is uncertain because the input is.

Where points hide

Points sit in origination charges on the standardised form, which is where the lender's own money is disclosed — the same section discussed in comparing two estimates on section A alone. That is helpful, because it means points are visible.

Two things obscure them anyway. A rate quoted in advertising may already assume points are purchased, so the version on your estimate can arrive with a higher section A than you expected. And a lender may quote a credit rather than a charge — negative points, where you accept a higher rate and receive money toward closing costs. That is the same trade run backwards, and it deserves the same arithmetic: how many months of the higher payment before the credit is repaid?

Negative points are the engine behind most "no closing cost" structures, which is why that mechanism belongs in the same analysis rather than being treated as a separate product.

When the calculation is not the whole answer

Break-even assumes you keep the loan on the terms you signed. Two circumstances break that assumption.

A line of credit with a draw period behaves differently from an amortising loan, because the balance itself moves. Points against a fluctuating balance have a payback that depends on a usage pattern you cannot yet observe — see the draw-to-repayment boundary for why the two structures resist the same maths.

And a borrower who is stretching to qualify should be sceptical of any structure that converts future flexibility into an upfront cash outlay. Cash paid at closing is not recoverable. A slightly higher rate, at least, can be refinanced away.

Points are a clean trade with a clear number attached. The number is only as good as your estimate of how long you will be there to collect it — and the underlying loan is secured on your home, which no rate reduction changes.

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