You're looking to get into real estate, so you start looking into financing options. Unless you have upwards of about two hundred thousand dollars, chances are you will be applying for a loan. There are several sources to choose from when obtaining a loan: Conventional, Commercial, Private, and Hard Money. You go through the application process, your credit score is sufficient, you secure a favorable interest rate, calculate your down payment, and then the lender mentions Mortgage Points. The expression on your face can't hide the fact that you have no idea what Points are all about.
A Mortgage Point is Also Known as a Discount Point
- Mortgage Points are paid at closing
- Paying Points is a prepayment of interest
- Paying Points does not reduce your loan amount
- Paying Points will reduce the total amount paid over the life of the loan
- A point is exactly equal to 1% of the loan amount.
|point||loan amount||point amount|
Mortgage Points also known as Discount Points, simply put is a prepayment of interest before the loan begins. There are many reasons why points come up during a loan process. One reason is a lender offers Discount Points is to help a prospective property owner save money over the life of the loan. Once the amount of Points have been agreed upon, the prospective property owner pays the point amount on the closing date for the loan. Since the owner has made interest payments on the closing date, the interest rate will have to be adjusted (lowered) to account for the interest already collected on the loan. A lower interest rate reduces the monthly payment and the total interest collected on the loan. Although the payments are lower and the interest collected will be significantly lower, it will take several years before you ever reap the benefits of paying points. You should only pay Points if you plan to stay in the loan until its completion. If you plan on refinancing then there is no need to pay Points because you will never see the savings.
Another reason a lender requires Points is to limit its losses just in case the loan goes into default or is refinanced through a different lender. If your credit score indicates that you are not a trustworthy borrower a lender feels more comfortable if they get more of their money up front. A lender which requires Points will usually request a point range between 4 and 8 Points to minimize potential losses. By charging points the lender makes an instant profit on the loan in addition to any other fees charged. Due to already making a profit up front, if the loan is refinanced or defaulted, the lender's losses are minimal if any.
Here is a simple example. It does not represent an actual loan. Contact a financial institution for more accurate information.
|descriptions of amounts||loan with points||loan without points|
|points taken||4 points||none|
|adjusted interest rates||4.0%||4.5%|
|term of loan||30 years||30 years|
|interest collected full term||$143,739||$158,219|
As you can see in the example above, choosing 4 points and paying $8000 up front reduces your interest rate by 0.5%, it also reduces your monthly payment $18, and saves you $14,480 over the life of a 30 year loan.
This information is for reference and in no way represents an actual loan. Please contact a professional for actual loan terms, or advice on different loan packages.