Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
About Mortgage Discount Points
Today let us know about mortgage discount points. What are they and should you pay them?
Now if you are in the market to purchase a home or refinance your existing mortgage loan there is no doubt you are going to encounter the term ‘discount points’.
What does a Discount Points Mean?
A discount point is defined as a prepaid interest that you pay in exchange for a lower mortgage rate.
When we are obtaining a mortgage, discount points are prepaid interest that you give to lenders and here we are not talking about any points paid on loan origination, we are talking about prepaid interest and the way it can be calculated.
Working of Discount Points
One discount point equals one percent of your loan amount.
This is a fee you pay at closing.
Discount points can be a legitimate fee used to lower your mortgage interest rate however discount points are often abused by mortgage companies to make their offers seem more attractive by offering unnatural low mortgage interest rates.
This is also called, ‘buying down your rate.’
What is Par Rate?
You would also need to know what is a “par rate,” which means no discount points, no point rate.
Let us say it is 4% which is the undiscounted rate and of course that interest rates going to be based off on your FICO, what type of loan are you taking, how much are you putting down are all that would be considered.
How do the Discount Points Work?
Suppose for example – if you offer one point to the lender you are basically giving one percent of the loan’s value.
So let us say it was a hundred thousand dollar loan, and you are offering to pay the lender one thousand dollars up front, it does not go towards the principle it is just based on the principle that we calculated.
But it is actually prepaid interest now in exchange.
So as we said earlier, suppose the undiscounted rate is 4% and you want to pay one point to get down to 3.75% so you have to do the payment difference between 4% over 30 years or 15 years of your loan term versus 3.75 over the number of years.
Why would you prepay interest and how is it beneficial for you to do in exchange for this one point?
The lender offering you a slightly lower rate for that $1000 is not a fee that you pay multiple times or every year it is a one-time fee that is very important.
So that is really the math about whether a discount point works and it always depends, on your goals on what you want to accomplish, also depends on your monthly cash flow needs.
If that payment quoted by the lender is too high then you need to work with them to get it down.
Maybe buying it down if you have the capital or if you are getting a stellar credit, you know a seller concession from the seller can help buy down your rate. So everything is always “it depends” and not plain black and white.
Advantage & Disadvantages of Discount Points
the benefit of a discount point can be enjoyed by the borrower only if he plans to hold on to the mortgage long enough to save money from the reduced interest payments.
For a lender, it is beneficial because he receives upfront cash improving his liquidity immediately instead of waiting for the interest payment overtime.
Again do you plan to take this house for more than ten years? Only then does it make sense to get that point if you are thinking you are only going to live there for a year and move it probably doesn’t make sense.
It is really important to do this equation because sometimes people get psychologically tied to one rate and they don’t care how many points they just want the rate.
Sometimes lenders are not going to quote in full points it could be 0.2 or 0.375 it could be a whole myriad of different things.
One last important thing for you to note is that points change every day not the cost of the one point is always 1% of the loan amount, but what can change is the rate that you get for what you are buying in points so a lot of people assume if I buy one point the rate goes down one percent no that is not how it is, depending on the market what the margins are what the market is doing.
Just as rates change every day so do the points associated with them so if you get a quote on Monday it is not guaranteed on Tuesday.
Conclusion
So in a nutshell a discount pint is an exchange of interest your paid interest today in exchange for a lower rate thought the life of the loans.
