When to buy a loan discount point...

One option you have when obtaining a mortgage is to pay a loan discount point to lower the interest rate on your mortgage.  In most cases, a loan discount point will cost 1% of the loan amount, and will lower the interest rate by 0.125% over the life of the loan.

For example, on a 30 year, $200,000 loan at 6.5%, with no discount points, your principal and interest payment would be $1,264.14.

If, however, you paid one point, the $200,000 loan at 6.375% would require a principal and interest payment of $1,247.74.

The cost of the loan discount point would be $2,000, and it would save you $16.40 each month.  Thus, it would take 122 months (10 years, 2 months) before you started to realize any savings.

However, to take it one step further, we should include the tax benefits of having bought the loan discount point.  The $2,000 is tax deductible, thus if you are in the 25% tax bracket, you would have a tax savings of $500, and only need to recoup $1,500 of savings.  By including this tax perspective, it would only take 92 months (7 years, 8 months) for you to start seeing savings for having bought the discount point.

Bottom line --- in the examples above, if you don't plan to own the house for more than 7-ish years (or 10-ish years), it is likely not worthwhile to buy the loan discount point.