If you're buying a home or planning to in the future, you’ve likely heard about rising interest rates. However, another factor is also raising mortgage costs: discount points. According to a recent study by the Federal Reserve, discount points—fees paid at closing to reduce interest rates—have significantly increased the up-front costs of getting a mortgage. This change impacts many buyers, so it’s essential to understand what discount points are, how they affect your overall mortgage cost, and why they’ve become more common in recent years.

Discount points are essentially pre-paid interest that buyers pay up front to reduce their loan's interest rate. Each point usually costs 1% of the loan amount and can lower the interest rate by about 0.25%. For example, on a $300,000 loan, one point would cost $3,000 and could lower your interest rate by roughly 0.25%.

The Federal Reserve study found that the use of discount points has increased sharply. In 2021, when interest rates were very low, almost no one used points. By 2023, however, many buyers paid an average of 0.7 points, and a substantial number paid over one point to buy down their rates. This shift is partly due to higher rates, which made borrowers more inclined to pay extra up front to reduce their monthly payments.

Homebuyers in 2023 paid about $6,500 at closing on average, up from $4,900 in 2021. This increase is largely due to the growing use of discount points, which make up a larger portion of the up-front costs for buyers. According to the Fed study, net points and fees have doubled from 2021 to 2023, moving from $1,500 to nearly $3,500 on average.

1. Higher Up-Front Costs: Expect higher up-front costs, especially if you’re considering discount points.

2. Slight Interest Rate Savings: While paying points can lower your interest rate, the benefit can vary widely depending on the lender.

• Third-Party Costs Remain Stable: Fees for services like appraisals and title insurance haven’t changed much, averaging around $3,000.

• Lender Credits Are Scarce: With mortgage rates still high, lender credits—funds provided by the lender to offset closing costs—are less common than they were in the past, making it harder to reduce closing costs without paying more up front.

For most of the past decade, mortgage rates were low enough that discount points weren’t widely used. As rates have risen, however, paying points has become a way for buyers to manage monthly costs. Interestingly, the Fed study suggests that the overall rise in discount points may actually reflect the costs lenders face in mortgage lending today rather than a strong demand from borrowers to lower their rates.

According to the Fed's research, if discount points hadn't risen, mortgage rates might have increased even more. So, while points add up-front costs, they may also keep rates from climbing as quickly, which can be beneficial to borrowers in the long run.

For those entering the housing market or planning a future home purchase, these findings underscore the importance of planning for potentially higher up-front costs. With discount points adding thousands of dollars to closing costs, it’s important to:

1. Consider All Loan Options: Compare offers from various lenders to find a deal that balances rate reduction with manageable closing costs.

2. Understand the Long-Term Impact: Paying discount points might lower your interest rate, but weigh the savings over time against the added up-front expense.

3. Budget for Closing Costs: Expect higher costs than you may have in past years, as the average mortgage closing expenses have increased substantially.

While discount points can be a useful tool, they add complexity to the home-buying process. Understanding how these costs affect your overall budget and mortgage payments will help you make a well-informed decision on your next home purchase.

• Discount points have driven closing costs up significantly, with average costs now around $6,500.

• Points may save on interest rates but add up-front costs, so weigh the trade-offs based on your long-term plans.