What are Discount Points?
Getting a home loan can be stressful at times, but it doesn’t have to be, as long as you have a better understanding of what everything means. Home loans come with a lot of confusing information and jargon, and it can become hard to differentiate between everything. One thing that can be very confusing to many borrowers is how discount points can work for them, and ultimately save them the most amount of money over the life of a loan.
Before we can dive into how discount points work, let’s explain some commonly used mortgage abbreviations. TOP means Total of Payments, and PI stands for Principal and Interest. TOP is how much a loan will cost after it is completely paid off. To calculate TOP, you must take what you pay monthly (PI) times the number of months that you’ll be paying that payment. So, let’s say that your PI payment on a Conventional, 30 year loan for $98,000 at a note rate of 4% is $467.87/month. Your TOP would be $168,433.20. (Ex. $467.87 X 360 months = $168,433.20.) Imagine if there’s a way that your loan amount could go up to $110,000, but you’d have a 0% interest rate. That would mean that every penny of your payment would go towards principal after the loan was funded. Unfortunately, this is not a possibility, but there are ways to minimize your TOP amount. One way is discount points. Each discount point is equal to 1% of the loan amount.
So, let’s say a Conventional, 30-year loan for $98,000 at 4% interest gives you a PI payment of $467.87/month with no discount points. If you were to include 2 discount points ($2,000) into the loan ($100,000) to get you an interest rate of 3.5%, your PI payment goes from $467.87/month to $449.04/month. That’s a savings of $18.83/month! So here’s the math to illustrate why in this case discount points can make sense: $18.83/month for 360 months equals $6778.80 in savings in TOP! So, now instead of the loan costing $168,433.20 in TOP, it will end up only costing $161,654.4!
When do discount points not make sense, you ask? In this particular scenario, if you only plan on being in the home for a short time, using discount points would not make sense. To determine when discount points do make sense, one needs to calculate the “break even” point. When talking to a licensed loan advisor, he or she will be able to calculate this threshold for you in consideration of your short and long term goals.
Now that you have a better understanding of how discount points work, it may be a good time to see if you can save some money by refinancing to get a better loan structure by speaking with a licensed loan advisor.
Written by: Jason Adamowicz, Loan Advisor at Royal United Mortgage LLC
Published: 12/16/2015