Mortgage Discount Points can confuse and daze anyone planning a home mortgage or re-fi. Lately, curious clients have been asking Palm State Mortgage Company about the mysterious meaning of mortgage discount points as well as the advantages and disadvantages of them.
First of all, let’s determine an exact definition of the mysterious financial term “points.” Investopedia informs us that “Discount points are a type of prepaid interest or fees mortgage borrowers can purchase that lowers the amount of interest they have to pay on subsequent payments.”
Points to Ponder: Mysterious Mortgage Discount Points
Actually, points work on mathematics more than on mystery. Here is the formula:
1. Each and every discount point comes at a cost of 1 percent of the total loan amount.
2. Depending on the buyer, typically each point you purchase lowers the loan’s interest rate by one-eighth to one one-quarter of a percent.
3. You might also like to know that you can only deduct discount points can from taxes for the year in which you pay them, and only then if you meet specific qualifications. (We will talk more about tax deductions and mortgage points later–That’s a blog topic in itself.)
Demystifying Discount Points
Perhaps an example would clarify this idea. Let’s say Palm State Mortgage Company helps you find a great loan on a home for $200,000. If you do the math, you will realize every point you want to purchase would cost you $2000. Now, if we assume that the interest rate is 5%, just to make the numbers easy. If you calculate it you will see that each $2000 point you purchase will lower the interest rate on the mortgage by 0.25 %.
Thus, you could buy two points for $4,000 and the result would then be an interest rate of $4.50 percent. If you would like help with the math, there are many companies online that offer you the resource of a points calculator so you can see what points could do for you. Money-zine features a good one to visit: No magic. No mystery. Just Math.
So, How Do I Pay for My Points?
In the mortgage industry, we call this “Buying down a mortgage interest rate.” Surprisingly, you might not really need to break into your cash piggy bank. Especially in refinancing a loan with points, the lender can bundle them with other closing costs into the loan balance. That way, you avoid bringing your piggy bank of cash money to the closing.
The darker side to this rosy deal is however, you must realize you are reducing your equity position in the home.
Instead of processing a re-fi, if you are a borrower and you pay for discount points when purchasing a home, you will likely need to bring your piggy bank (cash) to the closing table. Remember, however, there are many varieties of mortgage situations. For example, sometimes a seller offers to pay up to a certain amount of the buyer’s closing costs.
Furthermore, sometimes other closing costs like the loan origination fee and title insurance charge, do not add up to that dollar limit. Thus the buyer might choose to add discount points, up to the seller’s limit. Just as the math reveals, the buyer in such a scenario basically lowers his interest rate for no extra charge.
Points and The Good, The Bad and the Ugly
Now that you know the formula, and you know your fiscal situation, you can see benefits for both lenders and borrowers when points are purchased. Borrowers achieve lower interest as time goes by. On the uglier side of the coin, this benefit is only an advantage if the borrower plans to retain the mortgage long enough to actually see savings from the decreased interest payments.
Point to Ponder #1 –the Good.
Once again, here at Palm State Mortgage, we turn to explanation by example. Let’s build a mathematical scenario. A borrower pays $4,000 in discount points. Thereby he saves $80 per month in interest charges. To break even, how long must he retain the loan? The solution is that he needs to hold onto the loan for 50 months or 4 years and 2 months. Then he will break even. That’s the good side.
Point to Ponder Number 2- The Bad (maybe)
On the other hand, if he (or you) knows his company will probably transfer him to a new location in two years, or if they might need to move to a larger house to accommodate two new children in three years, then the borrower is pretty sure he will sell or refinance his loan before the 50 month break-even point. In that case, Palm State Mortgage advises him to avoid the points and live with the slightly higher interest rate. Why? Remember, he would retain more of his equity standing in the house.
Point to Ponder #3 The Ugly (could be)
With all this focus on the borrower, you might wonder, “What is the benefit for the lender? There is always an advantage to receiving cash up front. Lenders who receive cash up front for points, at closing, do not have to wait for their profit in interest payments over time. Thus the lender benefits from discount points by receiving cash up front instead of waiting for money in the form of interest payments.
This enriches their liquidity reputation. In other words, cash is easier to spend than physical property or money tied up in time payments. Palm State Mortgage invites you to find out more about financial liquidity from our experts at Investopedia.
A Palm State Mortgage Special Note-A Moment for Memorial
Even as we celebrate our own Orlando escape from the brunt of Hurricane Irma, we would be remiss if we did not express our condolences to the people who lost family and friends in this hurricane season’s vast storms.
Harvey, Irma, Maria are good strong names but now they forever will bring the memories of their namesake devastating storms in 2017. Even as Floridians began to have restored power and time for repair from Irma, we heard of Maria’s attack on Dominica.
Then, our attention turned from the power of water to the power of earth as we heard of yesterday’s catastrophic earthquake in Mexico. Our hearts go out to the families of the victims of all of these disasters.
It certainly seems like our old world is being badly battered here in the last months of 2017. Even now, as the lights and power went off on the entire island of Puerto Rico, we send prayers into the darkness for the plights of our fellow human beings. At Palm State Mortgage Company, we pray and we keep faith:
Do you not know? Have you not heard? The Lord is the everlasting God, the Creator of the ends of the earth. He will not grow tired or weary, and his understanding no one can fathom. He gives strength to the weary and increases the power of the weak.
Even youths grow tired and weary, and young men stumble and fall, but those who hope in the Lord will renew their strength. They will soar on wings like eagles; they will run and not grow weary, they will walk and not be faint.