What are discount points and How to calculate?

If you're buying a home and getting a mortgage or you're thinking of refinancing a lot of times you'll hear lenders use the word point and this is usually a word that you hear when you're trying to consider whether should I buy my rate down? So I'm going to explain what points are and a simple calculation you can do to see if it makes sense to buy your rate down. The first thing is a point is one percent of the loan amount so if your loan amount is $200,000 one point would cost you $2,000. Now to be perfectly clear I'm talking about discount points right now. There are origination points that lenders used to charge but I don't know that many originators are still charging points because there are so many that don't like it. So one discount point of a $200,000 loan is $2,000.

Example of Discount Points

You're going to be getting a $200,000 mortgage, and you can get 4.5% interest with no points or 4.25% with half a point. So the first thing is what's half a point? Well, 1% of one point is $2,000, so half a point is $1,000. So the lenders offering you a slightly lower rate for a thousand dollars. This isn't a fee that you pay multiple times or every year, it's a one-time fee.

So the way you figure this out is you're gonna get the principal and interest payment for each rate. So at 4.5% that would be $1013.37 and then at 4.25% it would be $983.88. So the payment difference between those two interest rates is $30 a month. 

What you do next is you're going to take the amount that it would cost to get that lower rate which is $1,000 and then you're going to divide that by the payment amount, so $1,000 divided by 30. Then you're going to divide that by 12 because that represents one year. It would take 2.78 years for buying this point.

Why it's important?

If you plan to have this house for 10+ years, it makes sense to get to that point as It would take 2.78 years for buying this point. If you're thinking you're only going to live there for a year and move, it probably doesn't make sense. Now it's important to do this equation because sometimes people get psychologically really tied to one rate and they like don't care how many points they are getting, they just want a rate and sometimes it needs zero points zero cents

Now one last important thing for you to note, points change every day. Not the one point is always 1% of the loan amount but what can change is the rate that you get for what you're buying in points. So a lot of people assume "if I buy one point the rate goes down 1%," No, totally no. It's depending on the market what the margins are, and what the markets doing.

So if today I was quoting you 4.5% interest with no points or 4.25% with half a point and you call me tomorrow, there's a very good chance that I wouldn't be offering you the same exact rates and in structure, because just as rates change every day so do the points associated with them. So if you get a quote on Monday it's not guaranteed on Tuesday.
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