'Discount Points' is explained in detail and with examples in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Discount points are also sometimes known as simply points. They represent a type of interest that is paid in advance. A single discount point is equivalent to one percent of the total loan amount. Through charging borrowers points, lenders boost their loan’s yield to a total that is higher than the expressed interest rate.
Borrowers are able to give a bank or lender payment as a way of lowering the loan’s interest rates. The up front sum of money gives them a lower monthly payment. With every point that a borrower buys, their loan’s rate commonly falls by .125 percent. A buyer paying for points is not without risk. At some time within the life of the loan, the cost of the money given to lower the rate of interest will equal out to the money that you saved in being able to make lower amount loan payments because of the loan’s better interest rate.
Should you refinance the loan or sell the house in advance of attaining this break even point, then you will actually take a loss on the transaction. On the other hand, if you hold on to the property and accompanying mortgage for a greater amount of time than the break even, then you will actually save money on the purchase.
It goes without saying that the longer amount of time that you hold the property mortgage and financing with the bought discount points, the better this money used for the points actually rewards you. At the same time, a person who plans on purchasing the property and then selling it or refinancing it quickly will only lose money by not simply paying the higher rate of interest on the loan in lieu of buying points.
Discount points can also be bought to help you qualify for loans. If the loan qualification basis is grounded in your monthly loan payment against your monthly income, then you may only be capable of getting approval by buying the discount points to lower the rate of interest which will result in the lower monthly payment that your approval requires.
Discount points should not be confused with broker fees or origination fees. Discount points only serve to lower the interest rates. Origination fees are those that the lender charges for creating and closing the loan. They could sometimes be a different name for lowering the interest rate as well.
Borrowers who will stay in the house for a longer period of time should definitely consider buying points. Lower interest rates will pay off in savings over time. Any changes in the fees and costs for the loan will be shown to you in the last good faith estimate that the lender provides.
Sometimes when you buy points, you may be able to get a no closing cost loan. This usually happens when the bank is getting a premium interest rate. As their fee is made off of a higher starting interest rate on the note, it can be utilized to cover the closing costs.
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