Not sure why it’s there, but aversion to mortgage loan points is definitely something every borrower and consumer asks about. For the most part, there is a negative stigma attached to paying discount points.
There’s two forms of points which are an elective to pay in conjunction with procuring mortgage loan financing.
There used to be origination points which you don’t see too much of anymore. The more popular form of points is that of discount points.
Discount points are nothing more than upfront overhead you can choose to pay to secure a lower rate of interest on the mortgage loan you are taking out.
How does Mortgage Loans: The Discount Points Conundrum fit into the picture?
The conundrum people have is whether or not to pay discount points. The general rule of thumb with discount points is that if you can pay discount points and you can break even within 2 to 3 years, and you are planning to keep the property and/or have the loan that long, then mathematically it usually make sense to invest monies for rate reduction.
These monies can be financed into the loan amount or they can be paid separately at closing.
Let’s take a look at a $300,000 home loan. Let’s say the closing costs are $3,200.
Option A: An interest rate is available at 4.625% with no discount points.
Option B: By paying one discount point reduces interest rate to 3.75%.
Well let’s break out the math: the payment at 4.625% is $1542 per month. The payment at 3.75% is $1389 per month. The difference is $152 per month between the two rates of interest. We simply take our closing costs of $3,200 divided by $152 per month, and the breakeven is 21 months.
Most would say this scenario probably make sense.
That scenario is simply a cash on cash scenario using monthly savings to recuperate the initial costs, simple enough right? Well what if we factor in annual interest as well?
The initial annual interest at 4.625% at $13,875. We say initial because the loan would be amortizing and over time the amount paid to principle increases and the amount paid to interest decreases.
The interest at 3.75% is $11,250. So if you’re going to be keeping a loan for a long period of time obviously it makes sense to pay a discount point.
Here is the discount points conundrum broken down for mortgage loans.
When we are talking about discount points, we are talking about certain percentages of the loan amount which are placed in the discount points box on the closing statement. Discount points don’t always necessarily have to be 1 or 2% of the loan amount either.
Discount points work in eighths and here is the breakdown:
.125 of the loan amount
.25 of the loan amount
.375 of the loan amount
.5 of the loan amount
.625 of the loan amount
.75 of the loan amount
.875 of the loan amount
It doesn’t necessarily stop here either because it can also be one percentage point of the loan amount +.25% for example, in other words, in this scenario, the total discount points would be 1.25% of the loan amount.
How does interest rates changing affect the discount points conundrum?
Mortgage interest rates move daily and change in basis points. For example you might have one day of market trading where interest rates improved by 50 basis points.
What this would mean if you are looking at that 1.25% discount scenario? Instead of 1.25% total discount points it would be .75% of a discount point because the market improved by .5.
Yes, discount points on mortgage loans affect mortgage interest rates and both can and do change daily.
Paying discount points on a mortgage loan does not have to be a conundrum.
It boils down to 4 Factors:
- Mortgage loan time frame
- Monthly savings generated by paying points
- Annual interest saved by paying points
- Property holding time frame
Most mortgage loans being written today are none other than the benchmark mortgage-the 30 year fixed rate loan. Many times it actually does make sense to pay discount points to secure an interest rate that will in time become virtually untouchable.
Keep an open mind and make a decision on paying points, considering the four factors.
Get a mortgage loan rate quote with points or no points. We can evaluate together the mortgage loans available and work out the discount points conundrum.