1% Discount Points to Buy down Interest Rates
Discount points are an upfront fee paid on a loan to buy down the interest rate. One discount point on a loan will be equal to one percent of the loan amount. Discount points are used to prepay interest in advance to lower the monthly payment by lowering the interest rate over the term of the loan. Lowering the interest rate on a home loan using discount points will not always be necessary. The first thing to consider before deciding to use a discount point is how long will the buyer live in the house. Next, the future needs to be thought about, how much is the buyer willing to spend monthly on their house payment? How much money do they have to put towards the closing costs, and towards prepaid discount points? Many factors affect whether using discount points to buy down the interest rate is necessary.
For example, on a $300,000 loan with no discount points and taking the par rate of 3.5 percent, hypothetically, the payment would be $1347 per month based on the $300,000 loan amount. There are no break-even periods. Paying a one percent discount up front would be equal to $3,000 on a $300,000 loan. A one percent discount point might buy the interest rate down to 3.25 percent. The buy-down to $1305 saves $42 a month. Take $42 divided into the $3,000 which results in a break-even period of 72 months or six years. To come out ahead, the borrower would need to live in the house for 6 years or more.
2% Discount Points
A 2 percent buy down in discount points also lowers the interest rate. Monthly payments will be lower and it will have a break-even period of 73 months. After the discount points are bought in advance, a refund cannot be given. If the borrower decides to sell before the six years, they cannot get their money back. If the borrower wants to refinance in the future, discount points may or may not be the right option. Some lenders will put a lot of discount points on there and they’ll get the interest rate very very low but the borrower needs to make sure the costs will be recouped. As a borrower, it is important to be aware of what a discount point is, in order to know where money is going.