When applying for a mortgage, you are likely to hear terms you are unfamiliar with. One of these terms is mortgage points and it is important to understand what they are and how they impact your mortgage. There are two types of mortgage points which are origination points, and discount points. Origination points are direct fees paid to the lender or mortgage broker. Discount point on the other hand can have an impact on your mortgage interest rate, and on your total mortgage payments.
What is a Discount Point?
Discount points are fees paid to a lender in return for lowering your interest rate. The points are quoted as part of your interest rate, for example, you may receive a quote of 4.25 percent with zero points. Your lender may also offer you the option of lowering your interest rate if you pay points. For example, instead of 4.25 percent interest with zero points, the lender may offer a rate of 4 percent with one point. In nearly all cases, paying one point will lower your interest rate by one-quarter of a percent.
How Are Points Calculated?
Points are based on a percentage of your mortgage amount. If your total loan amount is $500,000 and your lender is asking you to pay a point, the amount would be $5,000. This amount is paid upfront at the time of your loan application, or at the time your loan is approved.
Why Should you Buy Down Your Interest Rate?
Buying down your interest rate in exchange for a discount point can save you thousands of dollars over the term of your loan. In some cases, a borrower may have to buy down their rate to meet debt to income ratio requirements since paying discount points means lower monthly mortgage payments.
Here is how a buy down of interest rate would impact your monthly mortgage payment:Loan Amount$500,000Interest Rate4.25 percentLoan Term30 yearsPoints0
Estimated Mortgage Principal and Interest Payment: $2,459.70
The same loan if you pay a single point to have your rate lowered by one-quarter of a percentage would look like this:Loan Amount$500,000Interest Rate4.25 percentLoan Term30 yearsPoints1
Estimated Mortgage Principal and Interest Payment: $2,387.08
Over the life of your loan, which would be 360 payments (12X30), you would save $26,143.20 in return for buying one discount point. One discount point in this case would cost you $5,000 up front which means a total savings of more than $21,000 over the life of the loan.
Keep in mind, discount points may be used for both purchase loans and refinance loans and on any type of loan program including adjustable rate mortgages.
When to Avoid Discount Points
Before deciding to buy down your interest rate, it is important to understand when you will break even after paying a discount point. In the case referenced above, you will break even after 5 ¾ years. This is calculated by finding the difference between the two monthly payments, in the case referenced above, $72.62 and calculating when that amount would reach the amount you paid for the discount points. Therefore, if you are not going to stay in your home at least six years, paying discount points may not be practical.
Remember, as a loan officers I am uniquely qualified to assist you in finding the right mortgage to help you achieve your dream of home ownership. Contact me today whether you are purchasing your first home or considering refinancing your existing mortgage.