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Understanding Discount Points

During the process of buying a home there are many confusing concepts and terms thrown at the buyer. One of the most difficult aspects of home mortgages to grasp is discount points. Researching the topic and carefully asking questions of the mortgage lender are good places to start.

With this information the smart homebuyer can determine how best to use this abstract concept.  There are two types of points that are made reference to in loan application process. The first thing to do is understand what they are and their difference from one another.

Let’s get started with origination points.

They are charged by the lending financial institution to help recoup their loan processing costs. Certain lenders will be flexible with origination points and help their client reduce or completely do away with these points. Negotiation on this issue is totally dependent on the individual lender. Not all will be able to honor the customer’s request.

The other type of point connected to the home mortgage loan process is discount points. Discount points are used to reduce the client’s interest rate. Here is where things get a little tricky. A discount point is generated from a percentage of the entire loan amount. To give the customer a better idea here is an example.

One point charged on a $100,000 loan would be worth $1000. One half of a discount point would be $500 on the same $100,000 mortgage loan. If the consumer has decided on an adjustable rate mortgage, one discount point could lower the interest rate .375%.

From the fixed rate mortgage angle, the same point could reduce interest by .250%. One advantage to using the discount point system is that the savings on the interest rates is good for the whole life of the mortgage loan.

Each lender is different and their equations for determining the actual worth of a discount point vary. It would be a good idea to check on this while the consumer is shopping around for a lender. Some other bits of useful information to know about discount points are that points won’t show up in the loan fees list. They are not considered fees.

Discount points aren’t required for a home mortgage loan and as such are not added into the fees. They are an optional expense used to lower the loan’s interest rates.

The homebuyer should consider several things when deciding if they want to take advantage of discount points. The goal is to save the buyer valuable dollars and in some cases the use of discount points could actually be a disadvantage. There are times when the client should pay very few if any discount points. If the mortgage loan in question is an ARM, then the customer should only pay zero or a few points.  Other times to keep points low are when the homebuyer only plans to live in the home a few years.

Discount points won’t help save much money in the short run. If the client is planning to refinance the mortgage in a few years, then discount point usage should be kept to a minimum. The situations to consider paying more discount points are in the event the homeowner plans to stay in their home for many years, refinancing isn’t on the horizon, and the customer has plans to use their property as an investment after they move.

In these situations, it may make good financial sense to utilize discount points to the fullest.  If the homebuyer does their homework and fully understands the pros and cons of discount points, they will have a huge advantage in determining if this is the right step for them.