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Tag: discount points

Why Are Mortgage Lenders Requiring Upfront Points Today?

There’s been a recent change in the mortgage marketplace, as lenders are now requiring borrowers to pay upfront discount points when obtaining a home loan.

This is much different than in years past, when borrowers could easily qualify for a home loan with no points – and in some cases even receive a lender credit.

To find out more about discount points, please refer to this article…

Why Is This the Case?

Today’s situation has everything to do with volatility in the mortgage market over the last few years.

In essence, it’s very difficult for lenders to determine the value of a mortgage consummated today, because it’s unclear where mortgage rates go next.  Lenders need to make sure that they don’t lose money on each loan they originate.

So, to guard against this unknown, nearly all lenders are charging discount points to ensure at least some profits are being captured upfront.

Why Do Mortgage Lenders Charge Points?

Mortgage lenders charge points to collect profit upfront as opposed to over time via regular monthly interest payments.

Instead of waiting to collect interest each month once the loan is closed, they can collect some money upfront.

Lenders use upfront points to manage their risk. By requiring borrowers to pay discount points, lenders can ensure a more predictable profit over the life of the loan.

selective focus photo of stacked coins

This can be particularly important when interest rates are expected to rise, as it helps lenders secure a steady income regardless of market fluctuations.

Mortgage investors generally make money from the interest charged on the loans they provide. However, many of the mortgages originated today might be refinanced quickly, all but eliminating their projected revenue stream.

By requiring up-front points, the lender is compensated for the reduced interest income they would have received over the life of the loan.

How Will These New Mortgages Perform for Lenders and Investors?

Because mortgage rates have more than doubled in a short period of time, there’s a great deal of uncertainty regarding recently-originated home loans.

The big concerns for lenders and mortgage investors is a situation where rates improve enough for many of these borrowers to refinance.

Will those borrowers who obtained mortgages in 2022 and 2023 keep them for the long haul, or will they quickly refinance them if/when mortgage rates improve?

Per The Truth About Mortgage’s article, “a recent stat from Black Knight found that at least 10% of 2022 mortgages would become refinance candidates if the 30-year fixed fell to 4.75%”.  And many believe that number is low…

So, if these homeowners refinance, their loans no longer earn profitable interest for the investors. In normal times, lenders can sell their loans to investors at a premium, and use the proceeds to cover their commissions and your closing costs (via lender credits).

Currently, however, this is proving difficult because the value of these loans is essentially unknown. Hence, the profit is being taken upfront in the form of discount points.

In Conclusion

Today’s current mortgage rate environment is much more volatile than in years past. This has made it difficult for investors to determine the value of their underlying loans.

This is why many borrowers are seeing multiple mortgage points attached to today’s mortgage rates.

For example, if you’re planning to stay in your home or hold that investment property for a long time and have the upfront funds available, paying points could be a financially sound decision.

On the other hand, if you’re planning to move or refinance in the near future, paying extra upfront points might not provide as much benefit. It’s important to always compare the total costs and potential savings over the life of the loan before making a decision.

Do reach out to me to discuss the options of paying points…and how much!

Understanding Discount Points – A Primer

There is a fair amount of confusion from prospective buyers about mortgage “points”.  What are they? Why do they exist?

Discount points are a one-time, upfront mortgage closing costs, which give a mortgage borrower access to “discounted” mortgage rates as compared to the market.

In general, one discount point paid at closing will lower your mortgage rate by 25 basis points (0.25%).

Do they help or hurt they buyer?

The answer, of course, is “it depends”.

Dan Green at The Mortgage Reports does a fantastic job in highlighting the definitions and costs/benefits of the paying points. You can find out more here….

By the way, the IRS considers discount points to be prepaid mortgage interest, so discount points can be tax-deductible.

What Are Mortgage Discount Points?

When your mortgage lender quotes you the interest rate, is typically quoted in two parts.

The first part is the mortgage rate itself, and the second part is the number of discount points required to get that rate.

You’ll notice that, in general, the higher the number of discount points you’re charged, the lower your mortgage rate quote will be.

Discount points are fees specifically used to buy-down your rate.

On the settlement statement, discount points are sometimes labeled “Discount Fee” or “Mortgage Rate Buydown”. Each discount point cost one percent of your loan size.

Assuming a loan size of $200,000, then, here are a few examples of how to calculate discount points for a mortgage loan.

  • 1 discount point on a $200,000 loans costs $2,000
  • 0.5 discount points on a $200,000 loan costs $1,000
  • 0.25 discount points on a $200,000 loan costs $500

Discount points can be tax-deductible, depending on which deductions you can claim on your federal income taxes. Check with your tax preparer for the specifics.

How Discount Points Change Your Mortgage Rate

When discount points are paid, the lender collects a one-time fee at closing in exchange a lower mortgage rate to be honored for the life of the loan.

The reason a buyer would pay discount points is to get the mortgage rate reduction; and, how much of a mortgage rate break you get will vary by lender.

As a general rule, paying one discount point lowers a quoted mortgage rate by 25 basis points (0.25%). However, paying two discount points, however, will not always lower your rate by 50 basis points (0.50%), as you would expect.

Nor will paying three discount points necessarily lower your rate by 75 basis points (0.75%)

As outlined by Dan Green in his Mortgage Report article, here’s an example of how discount points may work on a $100,000 mortgage:

  • 3.50% with 0 discount points. Monthly payment of $449.
  • 3.25% with 1 discount point. Monthly payment of $435. Fee of $1,000.
  • 3.00% with 2 discount points. Monthly payment of $422. Fee of $2,000.

You’ll note that when you pay discount points come, it costs at a cost, but it also generates real monthly savings.

In the above example, the mortgage applicant saves $14 per month for every $1,000 spent at closing. This creates a “breakeven point” of 71 months.

Says Green, “Every mortgage loan will have its own breakeven point on paying points. If you plan to stay in your home beyond the breakeven and — this is a key point — don’t think you’ll refinance before the breakeven hits, paying points may be a good idea.”

Otherwise, points can be waste.

“Negative” Discount Point Loans (Zero-Closing Cost)

Green highlights another helpful aspect of discount points is that lenders will often offer them “in reverse”.

“Instead of paying discount points in order to get access to lower mortgage rates, you can receive points from your lender and use those monies to pay for closing costs and fees associated with your home loan,” he says.

The technical term for reverse points is “rebate”.

Mortgage applicants can typically receive up to 5 points in rebate. However, the higher your rebate, the higher your mortgage rate.

Here is an example of how rebate points may work on a $100,000 mortgage:

  • 3.50% with 0 discount points. Monthly payment of $449.
  • 3.75% with 1 discount point. Monthly payment of $463. Credit of $1,000.
  • 4.00% with 2 discount points. Monthly payment of $477. Credit of $2,000.

Homeowners can use rebates to pay for some, or all, of their loan closing costs. When you use rebate to pay for all of your closing costs, it’s known as a “zero-closing cost mortgage loan”.

When you do a zero-closing cost refinance, you can stay as liquid as possible with all of your cash in the bank.

Rebates can be good for refinances, too, as loan’s complete closing costs can be “waived”. This allows the homeowner to refinance without increasing its loan size.

When mortgage rates are falling, zero-closing cost mortgages are an excellent way to lower your rate without paying fees over and over again.

Please do reach out to me to find out more about how utilizing discount points can help you in your next transaction!

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