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Understanding Discount Points

Discount Points: Pay Upfront and Save in the Future?

Discount Points: Pay Upfront and Save in the Future?

Orange County, CA – There are many decisions to be made when it comes to selecting the right mortgage. One area in particular confuses a great deal of people looking to take the leap into the land of mortgages. That is the topic of discount points.

Just the name “discount” conjures images of a sale. Who doesn’t like a discount? Merriam Websters dictionary defines discount as a reduction made from the gross amount of value of something.

When you choose to buy a property, you will also choose whether or not to pay points. Origination points are fees paid to the lender. These points are not to be confused with their sibling discount points. Discount points enable the borrower to be able to take up a lower interest option. By paying a discount point you are pre-paying interest and reducing the future interest paid. Points of this nature play an important part of how lenders market their products. You will often find companies offering incredibly low rates only to discover that the borrower has to pay discount points in order to be able to secure the low interest rate offered.

What everyone wants to know about points of course, is whether or not they make financial sense. Determining whether or not to pay discount points depends on your goals for the property. Knowing how long you intend to have the loan is very important. Is this a starter home? Retirement home? Long-term investment or short-term flip? Once we know the time in the loan we can calculate a break even mark and assess the repayment plan. The less time you plan on holding the loan the less financial sense it makes to pay discount points. It takes time for the monthly payment savings to offset the upfront costs.

For instance, let’s presume you can pay 1.00 discount point to buy your rate down from 3.500% to 3.250% on a $417,000 loan. The monthly savings is $57 each month. Since 1 point is equal to 1 percent of the loan amount, the upfront cost would be $4,170. In order to calculate the time it would take to break even we divide the cost of the point by the monthly savings. In this example it takes just over 73 months or 6 years to break even. Therefore, if you plan on having the mortgage for 6 years or more you would recoup your upfront expense to buy down the rate. Every month thereafter you would save $57 additional dollars. The savings can really stack up over a significant period of time. But if you do not plan on keeping the mortgage 6 years it would not be in your financial interest to buy down your interest rate. It always comes down to assessing the circumstances of the house purchase before making a decision.

Naturally, you can get in touch with us anytime to discuss your options in terms of home buying. We’re happy to look into the best way forward for you, and first class advice is always on hand!

Scott Storace

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