what are mortgage discount points
When it comes to your mortgage loan, you will hear the word “points” a couple of times during the process. Points are fees paid directly to the lender for processing your loan or reducing your interest rate.
Origination points are paid to your lender for giving you a loan. Discount points give you the ability to lower the interest rate on your loan.
In most cases, a point equals 1% of your mortgage loan.
Origination is the business term used to describe your loan process. This includes underwriting your loan, processing all of your paperwork, and closing on your loan. Your lender gets paid through origination points and through the interest you will pay over the life of your loan as part of your mortgage payment.
The number of points you pay is not set in stone, and you may be able to talk to your lender about reducing the number of points in order to reduce the amount you pay.
If an origination point equals 1% of the loan amount and the mortgage company is asking for 1.5 origination points, the origination points for a $250,000 loan = $3,750.
At tax time, origination points are not tax deductible if they also include closing costs or other fees. The points must be used for the purchase or build of your primary residence, and you have to pay them directly, meaning you can’t negotiate to have them included in your loan amount or paid by someone else at closing.
In general, a discount point gives you the ability to buy a lower interest rate by pre-paying some of your interest. If you’re not able to get a lower interest rate because of your credit score, you may still be able to take advantage of lower rates by paying for points. Each point will lower your interest rate by a certain percentage or fraction of a percentage. Your lender will establish the maximum number of points you can purchase.
When weighing the pros and cons of paying for discount points, you should take into consideration how long you plan on being in your home and having the mortgage.
Because interest is calculated based on a specific term (number of months) that you will be making payments, reducing your interest rate by pre-paying interest may not be a good idea if you’re planning on selling or refinancing your loan within a few years of getting it. You’ll see the benefit of discount points the longer you’re making payments.
ABC Mortgage, a hypothetical lender, will reduce your interest rate by .25% for each point you purchase and they will allow you to purchase up to 3 points. Each point costs 1% of your loan amount. You are getting a $250,000 loan, and you were offered an interest rate of 4%. The monthly principal and interest payment would be $1,193.54.
If you purchase a discount point, you can reduce your interest rate to 3.75%. Your principal and interest payment would be $1,157.79 per month. You will pay $2,500 for the points and receive a $35.75 savings per month in interest.
Are Points Worth the Cost?
You would have to make about 70 mortgage payments (5.83 years) to recoup the $2,500. If you sell or refinance before that point, you won’t get to see the benefit of your points purchase. If you’re planning on staying in your home long-term, you’ll pay less in interest over the life of your loan than if you hadn’t purchased points.
This is assuming that your home value stays the same. If your home value increases, the increase in value may offset any savings loss you’d see by selling or refinancing within the first five years of ownership.
Another thing to consider is the price itself. The $2,500 for points is on top of your down payment and other closing costs. If you qualify for a low- or no- down payment loan, the additional cost for points may be something you can afford.
When it comes to making a decision on purchasing discount points, it comes down to how long you plan on staying in your home to see the long term savings, and if you can afford the up-front cost.
The bottom line – if your lender decides to charge you origination points, these are to some extent, negotiable, but not optional.
Discount points are completely optional for the homebuyer. Some lenders don’t charge origination points, but rather a flat origination fee. In this case, you wouldn’t have origination points, but would still have the option to utilize discount points.
what are mortgage discount points
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What are (discount) points and lender credits and how do they work?
Generally, points and lender credits let you make tradeoffs in how you pay for your mortgage and closing costs.
- Points, also known as discount points, lower your interest rate in exchange for an upfront fee.
- Lender credits lower your closing costs in exchange for a higher interest rate.
These terms can sometimes be used to mean other things. “Points” is a term that mortgage lenders have used for many years. Some lenders may use the word “points” to refer to any upfront fee that is calculated as a percentage of your loan amount, whether or not you receive a lower interest rate. Some lenders may also offer lender credits that are unconnected to the interest rate you pay – for example, a temporary offer, or to compensate for a problem.
The information below refers to points and lender credits that are connected to your interest rate. If you’re considering paying points or receiving lender credits, always ask lenders to clarify what the impact on your interest rate will be.
Points let you make a tradeoff between your upfront costs and your monthly payment. By paying points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time. Points can be a good choice for someone who knows they will keep the loan for a long time.
Points are calculated in relation to the loan amount. Each point equals one percent of the loan amount. For example, one point on a $100,000 loan would be one percent of the loan amount, or $1,000. Two points would be two percent of the loan amount, or $2,000. Points don’t have to be round numbers – you can pay 1.375 points ($1,375), 0.5 points ($500) or even 0.125 points ($125). The points are paid at closing and increase your closing costs.
Paying points lowers your interest rate relative to the interest rate you could get with a zero-point loan at the same lender. A loan with one point should have a lower interest rate than a loan with zero points, assuming both loans are offered by the same lender and are the same kind of loan. For example, the loans are both fixed-rate or both adjustable-rate, and they both have the same loan term, loan type, same down payment amount, etc. The same kind of loan with the same lender with two points should have an even lower interest rate than a loan with one point.
Points are listed on your Loan Estimate and on your Closing Disclosure on page 2, Section A. By law, points listed on your Loan Estimate and on your Closing Disclosure must be connected to a discounted interest rate.
The exact amount that your interest rate is reduced depends on the specific lender, the kind of loan, and the overall mortgage market. Sometimes you may receive a relatively large reduction in your interest rate for each point paid. Other times, the reduction in interest rate for each point paid may be smaller. It depends on the specific lender, the kind of loan, and market conditions.
It’s also important to understand that a loan with one point at one lender may or may not have a lower interest rate than the same kind of loan with zero points at a different lender. Each lender has their own pricing structure, and some lenders may be more or less expensive overall than other lenders – regardless of whether you’re paying points or not. That’s why it pays to shop around for your mortgage. Explore current interest rates or learn more about how to shop for a mortgage.
Lender credits work the same way as points, but in reverse. You pay a higher interest rate and the lender gives you money to offset your closing costs. When you receive lender credits, you pay less upfront, but you pay more over time with the higher interest rate.
Lender credits are calculated the same way as points, and may appear on lenders’ worksheets as negative points. For example, a lender credit of $1,000 on a $100,000 loan might be described as negative one point (because $1,000 is one percent of $100,000).
That $1,000 will appear as a negative number as part of the Lender Credits line item on page 2, Section J of your Loan Estimate or Closing Disclosure. The lender credit offsets your closing costs and lowers the amount you have to pay at closing.
In exchange for the lender credit, you will pay a higher interest rate than what you would have received with the same lender, for the same kind of loan, without lender credits. The more lender credits you receive, the higher your rate will be.
The exact increase in your interest rate depends on the specific lender, the kind of loan, and the overall mortgage market. Sometimes, you may receive a relatively large lender credit for each 0.125% increase in your interest rate paid. Other times, the lender credit you receive per 0.125% increase in your interest rate may be smaller.
A loan with a one-percent lender credit at one lender may or may not have a higher interest rate than the same kind of loan with no lender credits at a different lender. Each lender has their own pricing structure, and some lenders may be more or less expensive overall than other lenders – regardless of whether or not you’re receiving lender credits. Explore current interest rates or learn more about how to shop for a mortgage.
The chart below shows an example of the tradeoffs you can make with points and credits. In the example, you borrow $180,000 and qualify for a 30-year fixed-rate loan at an interest rate of 5.0% with zero points. In the first column, you choose to pay points to reduce your rate. In third column, you choose to receive lender credits to reduce your closing costs. In the middle column, you do neither.
Whether or not you should pay points or agree to a higher interest rate in exchange for a lender credit depends in part on how long you plan to keep the loan. If you are unsure, ask a loan officer to show you two different options (with and without points or credits) and to calculate the total costs over a few different possible timeframes. Choose the shortest amount of time, the longest amount of time, and the most likely amount of time you can see yourself keeping the loan. You can also review your options with a HUD-certified housing counselor.
When comparing offers from different lenders, ask for the same amount of points or credits from each lender.
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