Should I pay discount points when locking my interest rate?

For those looking to purchase to refinance a home, there might be some shellshock as it relates to costs associated with getting a home loan these days. It’s no surprise we are still in an inflationary environment and home loan rates are still feeling the effects of the broader inflationary environment. As a result, you might have to pay what are called discount points when securing a mortgage loan to purchase or refinance a home. Here are some things you should consider to make the most out of your money available…

Discount points are nothing more than upfront overhead paid in order to secure a lower interest rate. In the world of mortgage finance, the higher, interest rate lowers the amount points. The lower the interest rate, the more points and the higher the fees. Here’s an example let’s say you’re purchasing a home today and you can secure 5.75% by paying the cost of say two discount points of the loan amount and let’s say your loan amount is $500,000. So if a 5.75% interest rate is $10,000 of points in this illustration. Let’s say, you could opt to take a higher interest rate say 6.5%, and pay half a point instead of the difference in payment between 5.75 and 6.5 is approximately $125 a month so you have to ask yourself $125 a month of payment worth $10,000 of cash? $10,000 of cash divided into $125 a month of payment is approximately 10 years to recuperate that money.

If you’re going to have this loan specifically for 10 years one might argue it could be justifiable on the other hand, more than likely interest rates will be coming down in the near future certainly before your recapture timeframe is up thus pointing to the probability refinancing to lower your payment anyway without the excessive fees is probably likely. That being said, it might not make sense in such an illustration. The problem is this inflationary environment has created a situation where investors are worried about pre-payment risk. Most people today would absolutely refinance- given the opportunity if they took out a mortgage in the last 7 months. The investors in Wall Street know this and as a result, they’re front-loading the lower rates available today with prepaid points as a preventative measure to prevent pre-payment risk meaning that loans are paid off before the loan matures.

This has been happening since August 2022 and is still presently occurring within the mortgage-backed securities market. This relationship between paying excessive points in order for a small benefit in the interest rate and a small difference in payment most likely is probably going to be short term and when the market evolves and changes again and more investors come into the market and long-term interest rates, come down, most consumers will start to see the relationship between a 6.5 rate and a 5.75 category without paying points.

Based on the purchase price and your situation for this home purchase we’re speaking of, you might not have the type of availability or lateral movement and be able to take a higher interest rate to reduce fees because of your debt-to-income ratio credit score loan size or any other mortgage loan qualifying parameter, as a result, you might be required to have to pick a certain interest rate because your income won’t support payment with a higher interest rate at which point you’ll have to pay those points just for the privilege of being able to buy a home.

Regardless of your situation, however, on a home purchase, you can always ask the seller of the property to pay any associate discount points for you. Another flexible option is to have the seller pay points via a short-term fixed-rate by a down program called a 2-1 with the interest rate lower for the first two years of your mortgage. Assuming long-term rates come down, you might not ever be susceptible to the higher interest rate anyway and it’s paid with the seller’s money, not yours. If you’re thinking about getting prequalified for a mortgage,  and want to learn some more information about the best use of your money may begin today with an easy rate and cost quote.

 

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