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Buying real estate and getting a home loan: What are discount points?

When you’re quoted a rate on a mortgage, is that the best you can do? Often, it’s not. Something called discount points may be available to get you an even better rate on your mortgage and lower your monthly house payment. Whether you’re shopping for a mortgage loan in Denver CO, Miami FL, or in Dallas TX, understand your options when it comes to discount points and how they may affect your monthly payment.
Discount points defined
A discount point is one percent of the amount you’re financing. On a $200,000 loan, one discount point is $2,000. You might see discount points expressed in fractions, too. On $200,000, one and a half discount points is $3,000.

Why are they called “discount points?” Because your mortgage lender might let you reduce your interest rate by a point for each discount point you’re able to pay up front. That is, you might be able to “buy” a better rate — and lower monthly payment — on your loan. You might get a “discount” on what you thought was the best rate available in exchange for putting up some additional cash.

Discount points example
Let’s say you’ve been offered a 6.75% interest rate on a 30-year fixed rate mortgage loan. You’re going to finance $200,000. You have $3,000 available to you to either increase your down payment — so you’ll be financing $197,000 instead of $200,000 — or to buy one and a half discount points, and get your rate down to 5.25%. What should you do?

First, it’s important to understand that the answer won’t be the same for everybody. What might influence your decision whether to buy discount points?

• If you’re only planning to stay in the house or few years, or anticipate refinancing after just a few years, you might not want to buy discount points.
• If you’re getting an adjustable rate loan, it’s probably a better idea NOT to buy discount points.

Now, let’s look at the 10-year cost or savings involved in buying discount points or putting more down on your home.

Financing $197,000 over 30 years at 6.75% means you’ll pay $1,275 a month. You’ll have paid $153,329 after 10 years. Your home equity after 10 years — WITHOUT considering appreciation, just what you’ve paid down in principal — will be $31,957.

Financing $200,000 over 30 years at 5.25% means you’ll pay $1,104 a month. You’ll have paid $132,529 after 10 years. That’s a 10-year savings of more than $20,000! Better yet, your home equity after 10 years, WITHOUT considering appreciation, will be $36,103. You’ll have more than $4,000 more in equity even while paying $20,000 less.

How to decide about discount points
Now that you see the savings possible buy buying discount points up front, you’ll want to apply that knowledge to your situation. Saving $20,000 over 10 years doesn’t matter if you plan on moving and selling your house again in three years. Adding to your down payment gets you equity immediately instead of having to wait as you pay off principal.

Tags: real estate | financing | discount points

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This entry was posted on Friday, November 30th, 2007 at 11:02 pm and is filed under Real estate investment. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.