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 “discoun
ted” 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!
