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’.
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.
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.’
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.
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.
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.
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.
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.
If you are buying a home and getting a mortgage or if you are thinking of refinancing a mortgage, a lot of times you will hear the lenders using the word ‘point’.
This you will usually hear when you are trying to consider to buy your rate down.
In this post, we will explain what are mortgage points and check when it makes sense to buy your rate down.
A mortgage point is a cost to you as a buyer, to buy an interest rate that is better than what the lender has offered you according to your qualification.
One point equals one percent of your loan amount.
For example, if your loan amount is $150,000, one point would cost you $1,500.
Let’s say your lender has offered you 2.875% without points, however, you want to get 2.625%. The lender will say that they can get you that rate by charging you half a point on $150,000 which is $750.
This is not a fee that you pay multiple times or every year, it is a one-time fee to buy that rate down.
The points are better explained with an example so we are going to use one to understand when does it make sense to buy a point.
Let us take an example of a three hundred thousand dollar loan. One point is one percent of the loan amount which is three thousand dollars.
If the loan estimate provided by your loan officer says that there is half a point to get a 2.625% on a thirty-year mortgage, that means you have to pay $1,500 to the lender just to get 2.625%.
The monthly payments including principal and interest on 2.625% for 30 years are $602.48.
What you need to understand is when you pay that half a percent of the loan amount, how low of the rate are you getting.
If your lender is offering a rate with a buy-down point you also want to ask the lender what rate you can get without any mortgage points.
In this example we will take the interest rate that the lender can offer without points is 2.99%.
Once you have that you want to see how much is the difference in the monthly payments between both the rates.
The monthly payments including principal and interest on 2.99% for 30 years are $631.60.
If you are paying one point to lower your rate on an average you will get a quarter of a percent reduction on your rate and will have a difference of approximately twenty-nine dollars per month.
What you need to do is calculate how much time is it going to take to recoup the point charged and analyze if you are planning to stay in the house for that long.
In our example, it would take approximately 52 months, which is about four and a half years to recoup the points charged.
So it would make sense to buy down the mortgage points in this example only if you are planning to stay in this house for four years and three months or more.
If you are not planning to stay in the house for the time it takes to recoup the loan points charged, you might as well get a rate without any mortgage points.
The math to calculate if it makes sense to buy a mortgage point is given below.
150,000 Loan amount.
2.99% no points: Principal and interest payment=$631
2.625% with a .5pt cost: Principal and interest payment =$602
.5pt in this example is $1,500 so the cost to get the lower rate is $1,500
Payment difference between rates = $631-$602= $29
$1500 divided by $29 divided by 12 = 4.31
You would need to live in the house for over 4.31 years for it to make sense to buy mortgage points.
So the bottom line is, it is all about the math. Do not get mesmerized by the attractive rates advertised by the lenders.
You can also ask the seller to contribute towards your closing cost so that you don’t have to bear the cost for points if you are buying a new property.
However, if you are refinancing, you are responsible for paying the loan points.
Make sure you speak to your trusted loan officer regarding the loan points so that you can make an informed decision.