When applying for a mortgage, terms like “discount points” and “origination points” often come up, and understanding them is crucial to avoid costly mistakes. These concepts significantly influence your loan’s interest rate, monthly payment, and overall cost. This guide will delve into these terms, assisting first-time homebuyers, investors, and those considering refinancing to make informed, financially savvy decisions.
Deciphering Loan Discount Points
Loan discount points, also known as mortgage points or simply “points,” are a form of prepaid interest that mortgage borrowers can purchase to lower the amount of interest they’ll pay over the life of their loan.
Each discount point generally costs 1% of the total loan amount and can lower the loan’s interest rate by 0.25%. However, buying points isn’t the best option for everyone. If you plan to sell the property or refinance the loan before breaking even on the upfront cost of the points, consider reducing the amount paid in discount points and accepting a slightly higher interest rate.
Let’s consider a concrete example. Suppose you’re taking out a $350,000 mortgage with an interest rate of 6%. Without discount points, the monthly payment for principal and interest would be approximately $2,098. Suppose you purchase two discount points at closing. In that case, your interest rate might be reduced to 5.5%, reducing your monthly payment to around $1,986.
Remember, funds for buying down the rate can sometimes be negotiated from the seller as “seller paid closing costs.” This means the seller effectively pays for the discount points, benefiting you from the lowered rate and payment.
Unpacking Origination Points
Origination points differ from discount points. They represent fees borrowers pay to lenders or loan officers for evaluating, processing, and approving mortgage loans. Origination points can vary from lender to lender and are negotiable. However, they do not directly influence the monthly mortgage payments as discount points do.
Exploring the Impact on Different Loan Types
Loan programs from Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) each have unique rules concerning discount points and origination points. For instance, FHA can include discount points in the loan refinancing, which can benefit borrowers with less cash at closing.
Lowering the interest rate and monthly payment via discount points can also strategically increase your loan approval odds, especially if you’re on the border of debt-to-income limits.
Additionally, real estate investors may use this strategy to increase monthly rental cash flow by lowering the monthly mortgage payment.
The Role of Discount Points in Refinancing
When refinancing your mortgage, discount points can also play a crucial role. By buying discount points, you can reduce the interest rate on your new loan, saving you a significant amount of money over time. Most refinance loan programs allow the cost of discount points to be included in the loan amount as long as the total loan amount doesn’t exceed loan program underwriting and approval guidelines.
Calculating the break-even point lets you know how long you’ll stay with the mortgage to recoup the costs of buying the points.
For example, if refinancing reduces your mortgage rate from 6% to 5.5%, the savings in interest over the loan’s lifetime could be substantial.
Remember, when refinancing an FHA or conventional conforming loan, you should always explore the cost and potential savings of buying discount points.
Key Takeaways
Understanding the role of discount points and origination points is useful when considering a home loan or refinancing.
They can significantly impact your mortgage payment, interest rate, and the total cost of the loan.
Discount points lower your interest rate, which can save you money over the life of the loan, especially if you plan to live in the house for many years. On the other hand, origination points are part of the costs of getting the loan.
Points can also be used strategically to lower the new loan’s interest rate during refinancing. Make sure to calculate whether the lower rate’s savings will outweigh the points’ upfront cost over your expected time in the home.
Contact Steve Silver at Silver Mortgage, at 1-800-920-5720.
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