Ever see a mention of “points” in your loan estimate or closing disclosure when applying for a mortgage? You can rest assured that your lender isn’t playing some type of weird game with you or trying to keep score. When a mortgage company talks about discount points, they’re simply referring to an upfront fee you can pay to reduce the interest rate on your mortgage.
Understanding the points, fees or credits that might be included in your mortgage is an important part of making sure you’re getting a good deal on your home loan.
Discount Points Defined
The easiest way to understand discount points is by thinking of them as a type of prepaid interest. One point is equal to one percent of the cost of your mortgage. If you are getting a $200,000 mortgage with two discount points, you will pay an extra $2,000 upfront. In return, the mortgage company reduces your interest rate, usually by about .25 percent per point. If the rate you were initially offered was four percent and you purchase two points, your rate is reduced to 3.5 percent for the life of the mortgage. As the Consumer Financial Protection Bureau notes, you don’t have to purchase whole points. It’s possible to get a mortgage with 1.5 or 1.375 points, if you wish.
You can look at a lender credit as the opposite of a discount point. While a point increases the amount you pay upfront by decreasing your interest rate, a credit decreases the amount you pay upfront but increases your interest. Sometimes, lender credits are called negative points. They are calculated like discount points: One credit is equal to one percent of the total mortgage amount. When you get a no closing cost mortgage or refinance, you are getting a lender credit to cover those costs.
Points vs. Credit
How do you know whether to take the points or the credit when you refinance or apply for a new mortgage? It helps to look at how long you plan to live in the house and which option will cost you the least in the long run. Usually, if your goal is to live in a home for many years (and you have the cash upfront) — it makes sense to take the points. Why? You’ll enjoy a lower monthly payment. Plus, you can save money in the long run. However, if your cash reserves are limited and/or you plan on refinancing or moving within a few years, it might make more sense to take a credit. You don’t get the points you pre-pay back if you sell the home or refinance.
Talk to a mortgage specialist today to learn more about points and credits. They’ll help you discover if paying upfront or going the no closing cost route is right for you.