Discount points let a borrower pay cash at closing in exchange for a lower interest rate over the life of the loan. The question is not whether the rate improves but whether the buyer holds the loan long enough to recover the cost.
Points are prepaid interest expressed as a fee
Each point is a fee calculated as a share of the loan amount, paid at closing, in return for a reduction in the note rate.
Economically the borrower is prepaying interest. The lender receives money now instead of over time and adjusts the rate accordingly.
The exchange rate between cash paid and rate reduced is set by the lender and varies with market conditions, so it is not a fixed relationship.
Break-even is the cost divided by the monthly saving
The lower rate produces a smaller monthly payment. Dividing the upfront cost by that monthly difference gives the number of months required to recover it.
Before that point the borrower is behind. After it, every remaining month is a saving, and the saving continues for the rest of the loan.
Typical break-even periods run to several years, which is longer than many buyers expect when the rate improvement is presented on its own.
Refinancing and selling both end the clock early
The calculation assumes the loan survives to break-even. Selling the property or refinancing terminates the loan and forfeits the remaining benefit.
Since a meaningful share of mortgages are refinanced or repaid well before term, the effective holding period is often shorter than the borrower assumed.
Falling rates make this worse rather than better, because the incentive to refinance rises precisely when the purchased rate looks least attractive.
The cash has an alternative use
Money spent on points is money not available for the down payment, reserves or the costs that follow a move.
A larger down payment may remove mortgage insurance or improve the rate through a better loan-to-value tier, which competes directly with the points purchase.
For a buyer with limited cash, holding reserves is usually worth more than a rate improvement that pays back over several years.
Lender credits run the trade in reverse
The same mechanism operates in the other direction. Accepting a higher rate produces a credit from the lender that offsets closing costs.
That suits a buyer short on cash or one who expects to move within a few years, since the higher rate is paid only for as long as the loan exists.
Comparing offers therefore requires looking at the rate and the points together, because a quoted rate means little without knowing what was paid to obtain it.