One of the more frequent topics discussed between loan officers and borrowers center around discount points.
“What are points?” “Should I pay points?” “What about NO points?” And so on…
So today, I decided to give you some information and some things to consider:
- First, a definition- Discount Points are pre-paid interest that allows a borrower to lower their interest rate on monies borrowed. Because points are prepaid interest and mortgage interest is tax deductible, points are tax deductible in full in the year you pay them when you use the proceeds of the loan to purchase a home. (Consult your accountant for rules concerning points on refinances.)
- As an example, paying a point (one point is equal to one percent of the loan amount) may lower the rate on your 30 year mortgage .25%. To give some practical numbers to it:
- On $100,000 loan, one point would be $1000.00.
- The difference in your monthly payment from a 4% rate to a 3.75% rate on a 30 year fixed rate loan would be $14 ($478 vs $464).
- Are you better off spending $1000 today to save $14 a month? It will take you nearly 6 years to make your money back. For most, it’s easier to find $14 a month than to save $1000. On the other hand, if you expect to have this loan for 30 years, your $1000 expense will wind up saving you over $5000.
- Next, talk to your loan officer about ACTUAL prices. The old guideline of 1 point for .25% in rate doesn’t hold true every day or at every price point or at different times of the month or year. Mortgages are bundled together and sold in packages called MBSs (Mortgage Backed Securities). These MBSs often are bought and sold before there are loans to fill them up. A given company may have projected (and committed to deliver) a certain volume of loans at a particular rate. To attract these loans as their deadlines approach, they may offer a “deal”. There are times when a lender can make more money selling a 3.75% Note than a 3.875% Note because of other commitments. Ask your LO the different costs (in points) you would have with different rates. Then, calculate the time needed to recoup the monies.
- Often, I have advised clients closing toward the end of the year to pay points because they can “get back” a good portion of the cost quickly if they file their tax returns early. The theory is you can spend $1000 and get the benefit of it but, after your refund, maybe you really only spent $750.
- Many deals today are structured with seller’s concessions wherein the seller (as an inducement to get you to buy their home) offers to pay all or some of your closing costs. At time of contract signing, there is an estimation of what that will be. Whether your contract says a flat dollar amount or a percentage, there is often a few extra dollars available at time of closing. A few days before closing, you should ask your LO for a more accurate number because you may have a few bucks the seller can pay to secure you a lower rate. If you don’t do it, the seller just walks away with more money than they agreed to.
- Also, you can pay non-round numbers in points to achieve your objectives. It is not unusual to see loans today with 1.045 points or.781 points. For the lender, it’s about the yield that arises from the combination of rate and points.
- Lastly, points can work in reverse. Rather than paying them, you can “create” them for your own use. That is really what a lender-paid closing costs loan is. You pay a higher rate so the lender can then sell that loan for more money. The lender then makes the additional money available to you to spend on closing costs.
Pricing on your mortgage is complicated yet understandable. Take the time to look at it from multiple angles. Use your LO as a resource/advisor. That is where the good ones can add tremendous value. Most people only ask about rate and closing costs. Go deeper to get the real answers.