What are Mortgage Loan Discount Points?
Discount points are a form of prepaid interest or fee that mortgage borrowers can buy to reduce the amount of interest they pay on their following monthly payments—in effect, spending more up front to pay less later. Discount points can be deducted from your taxes.
Selling or refinancing the property before this break-even point will result in a net financial loss for the buyer, whilst holding the loan for longer than this break-even point will result in a net financial saving for the buyer. As a result, paying points will cost more than simply paying the higher interest rate if the aim is to buy and sell the home or refinance.
Mortgage Loan Discount Points Definition
Discount points, often known as mortgage points or simply points, are a type of prepaid interest offered by mortgage lenders in the United States. One percent of the loan amount is equal to one point. A lender effectively boosts the yield on a loan above the amount of the quoted interest rate by charging a borrower points. Borrowers can offer to pay points to a lender in order to lower the loan’s interest rate, resulting in a lower monthly payment in exchange for this up-front payment.
How do Mortgage Loan Discount Points work?
Discount points, a type of mortgage point, are a one-time, up-front mortgage closing cost that entitles the borrower to a lower interest rate over the life of the loan. Each discount point costs about 1% of the entire loan amount and reduces the loan’s interest rate by one-eighth to one-quarter of a percent.
The longer a loan is outstanding, the more interest it accrues—this is how financing works in general. As a result, points are appropriate for a fixed-rate, long-term mortgage (20 to 30 years) that is unlikely to be refinanced anytime soon.
Paying for Mortgage Loan Discount Points
A borrower who pays discount points is likely to be responsible for these fees. Many circumstances occur, especially in buyer’s markets, in which a seller offers to pay up to a specified dollar amount of closing fees. If the buyer’s other closing costs, such as the loan origination fee and title insurance premium, do not match this criterion, the buyer can typically add discount points to their loan and essentially cut their interest rate for free.
Discount points can reduce your mortgage interest rate without requiring you to pay them out of pocket, especially if you’re refinancing and the lender can roll discount points, as well as other closing costs, into the new loan total. This keeps the borrower from having to pay more money at the closing table, but it also lowers their equity in their home.
Should You Purchase Mortgage Loan Discount Points?
Discount points offer a particular benefit to lenders: they obtain cash up front rather than having to wait for money in the form of interest payments over time. The liquidity of the financial institution may be improved as a result of this.
Discount points have other advantages for borrowers, the most important of which is lower payments over the life of the loan. In essence, you are paying some interest up front (at the start of your mortgage) in exchange for a lower interest rate later on. This benefit, however, only applies if you intend to keep the mortgage long enough to save money from lower interest payments.
Mortgage Loan Discount Points Summary
In general, the longer you anticipate to live in your home, the more points you’ll save on interest during the loan’s term. At the end of the day, however, the value of discount points is determined by math. If you can manage to spend a few thousand dollars more up front, they can save you a lot of money in the long run, especially if the house needs to be renovated. Alternatively, they can be an unneeded expense that the borrower could have avoided with better preparation.
If you have any other questions regarding Mortgage Loan Discount Points contact the mortgage experts at 864-397-8500 or click Mortgage Rates Today!
Last Updated on 05/25/2022 by Mark Does
Financial Consultant and Author