Conventional Loan Points: What You Need to Know

You can lower your interest rate with discount points.

No points ban symbolA point is a pre-determined amount of money that a borrower pays in exchange for a lower interest rate on their mortgage loan. Points are also known as discount points.

When borrowers are looking for a mortgage, they may ask their loan officer about the points; and how it might impact their mortgage payments.

One thing to note is that the Internal Revenue Service (IRS) allows homeowners to deduct the cost of mortgage interest points from their federal income taxes.

What Are Points on a Mortgage?

There are a few things you should know about points on a mortgage. First, let’s start with what they are. A point is 1% of the loan amount. So, if you have a $100,000 loan, you would pay one point, or $1,000.

Next, let’s take a look at what they do. Any time you pay points on a mortgage, you are effectively paying for a lower interest rate. The lender will give you a discount off of their current interest. This is why it’s important to calculate whether it makes sense to pay points or not. With discount points, you are prepaying the interest on the loan.

Mortgage Discount Points vs. APR

People often confuse the APR rate and the loan rate. The Truth in Lending law, passed in 1968, requires the APR rate. The purpose of the APR rate is to give consumers a fighting chance to compare lenders.

The APR formula is confusing. In a nutshell, The APR rate is the sum of all fees charged by the lender for the loan. The higher the APR rate, the higher the lending fees. Needless to say, the APR rate flushes out unscrupulous lenders who are hiding excessive loan costs.

The ARP rate is just a way to compare lenders.

Example of How Mortgage Points Can Cut Interest Costs

When you're buying or refinancing a home, your mortgage points might help you save money on interest costs. Mortgage points are fees paid to the lender in exchange for a lower interest rate.

Here's an example. Assume the loan is $200,000 with a 4% interest rate. Over a 30-year period, the total interest paid is $143,739.01, with a monthly payment of $954.83. (principal and interest).

Now consider the loan with one discount point. One discount point is equal to one percent of the loan amount ($200,000 X 1% = $2,000), and one point lowers the total interest rate by about 1/4 percent.

If you agree to pay one point in this example, the total interest paid throughout the loan's term would be $133,443.23 and the monthly payment would be $926.23.

How much money would this borrower save if he or she paid one discount point?

Loan Amount Interest Rate Total Interest Monthly Payment
$200,000 4.00% $143,739.01 $954.83
One Point 3.75% $133,443.23 $926.23
Difference 0.25% $10,295.78 28.60

In this example, the borrower pays an extra point ($2,000) at settlement, but saves $10,295.78 in total interest and $28.60 in monthly loan payments.

What Is the Breakeven Point?

Your breakeven point is the amount of time it will take you to recoup the cost of the discount point(s). In the previous example, the monthly savings was $28.60 each month. Now if I divide the cost of the discount points ($2,000) by the monthly saving ($28.60), the result will be the number of months to break even.

$2,000 divided by 28.60 equals = 70 months. Almost 6 years.

If you are going to remain in the home for at least 6 years, and if you have the money to purchase a discount point, you will save money in the long run.

When you're buying a home, it's important to be aware of the breakeven point and how long it will take to reach it.

What Are Mortgage Origination Points?

Mortgage origination points are fees charged by lenders to originate a mortgage. These point(s), which are often called discount points, are expressed as a percentage of the loan amount. For example, if you pay two points on a $100,000 loan, you would owe $2,000.

Origination points are the cost of processing your mortgage. They do not affect the interest rate.

Who Pays for the Points?

When it comes to who pays for points on a conventional loan, it’s important to understand that there are two types of points: origination points and discount points.

The lender charges origination points for processing the loan.

So, who pays for points on a conventional loan? The buyer usually pays for the discount points, however, the home seller can pay for the discount point(s) up to the allowable limit.

If you’re refinancing your home, you can pay for all the points or none of the points. Generally speaking, the more points you pay for, the lower the interest rate on your loan will be.

Rotating question markFrequently Asked Questions (FAQs?

Q. Are there any drawbacks to using conventional loan discount points?
A. There are a few drawbacks to using conventional loan discount points. The first is that you have to pay for them out of pocket. This can be a big expense, especially if you're buying a home. Second, you may not recoup the cost of the points if you sell your home in the near future.

Q. Do conventional loans have discount points?
A. Yes, conventional loans can have discount points. This is a way for the borrower to get a lower interest rate on the loan. The more points a borrower pays, the lower the interest rate will be.

Q. How does the lender calculate these points?
A. The lender calculates points by multiplying the loan amount by the percentage rate of points. For example, if a borrower is seeking a $100,000 loan and wants to pay two points, then the total cost would be $2,000.

Q. How much does 1 point lower your interest rate?
A. It depends on the interest rate and the amount of the decrease. Generally, a one-point decrease in an interest rate will result in a savings of about $100 per year for every $10,000 you have borrowed.

Conclusion

In conclusion, conventional loan points are a way to get a lower interest rate on your mortgage. By paying points, you're essentially prepaying interest on your loan. However, it's important to weigh the costs and benefits of paying points before making a decision. If you're able to stay in your home for a long period of time, paying points could save you money in the long run. But if you plan on moving soon, you may not see much benefit from this investment.