Definition
Discount Points are upfront payments made by the borrower to the lender at the origination of a loan. These points are typically used to lower the mortgage interest rate in exchange for a cost that is a percentage of the total loan amount. Each discount point generally costs 1% of the mortgage amount and can reduce the interest rate by around 0.25% per point.
Examples
- Home Purchase: A homebuyer takes out a $200,000 mortgage. To lower the interest rate from 4% to 3.75%, they pay 1 discount point upfront, costing them $2,000.
- Refinancing Loan: During refinancing, a borrower chooses to pay 2 discount points to reduce the new mortgage rate from 5% to 4.5%, thus paying 2% of the $150,000 loan ($3,000) at closing.
Frequently Asked Questions
Q1: How much does one discount point cost?
- A: One discount point typically costs 1% of the total loan amount.
Q2: How do discount points affect monthly mortgage payments?
- A: Paying discount points lowers the interest rate on the loan, which in turn reduces monthly mortgage payments.
Q3: Are discount points tax-deductible?
- A: In many cases, discount points may be tax-deductible, but it’s advisable to consult a tax professional for specific situations.
Q4: How long do you need to stay in your home to benefit from paying discount points?
- A: This depends on the break-even point, but generally, if you plan to stay in your home for a long period, the savings on interest can outweigh the upfront cost.
Q5: Can discount points be financed in the loan amount?
- A: Yes, in some cases, discount points can be financed into the overall loan, increasing the loan amount but spreading the upfront cost over time.
Related Terms
- Loan Origination Fee: A fee charged by a lender for processing a new loan application.
- APR (Annual Percentage Rate): The annual cost of a loan to a borrower, including both interest and fees, expressed as a percentage.
- Closing Costs: The fees and expenses, over and above the price of the property, that buyers and sellers normally incur to complete a real estate transaction.
- Interest Rate Buydown: A financing technique where the interest rate is reduced, typically by paying discount points upfront.
Online Resources
Suggested Books for Further Study
- “Mortgage Management For Dummies” by Eric Tyson
- “Real Estate Finance and Investments” by William Brueggeman and Jeffrey Fisher
- “The Real Estate Investor’s Handbook” by Steven D. Fisher
Fundamentals of Discount Points: Real Estate Financing Basics Quiz
### What are discount points mainly used for?
- [ ] To increase the principal loan amount.
- [ ] To extend the loan term.
- [x] To reduce the interest rate on a loan.
- [ ] To improve the credit score of the borrower.
> **Explanation:** Discount points are paid upfront to reduce the interest rate on a mortgage.
### How much does one discount point typically cost?
- [x] 1% of the loan amount
- [ ] 0.5% of the loan amount
- [ ] 1.5% of the loan amount
- [ ] 2% of the loan amount
> **Explanation:** One discount point generally costs 1% of the total loan amount.
### How much of an interest rate reduction is typically achieved with one discount point?
- [ ] 0.10%
- [ ] 0.15%
- [ ] 0.20%
- [x] 0.25%
> **Explanation:** Generally, one discount point reduces the mortgage interest rate by around 0.25%.
### Are discount points tax-deductible?
- [x] Yes, in many cases.
- [ ] No, never.
- [ ] Only in specific states.
- [ ] Only for commercial properties.
> **Explanation:** Discount points may be tax-deductible, but it's advisable to consult a tax professional.
### When is it generally beneficial to pay for discount points?
- [ ] If you plan to flip the house within a year.
- [ ] If you intend to rent the house immediately.
- [x] If you plan to stay in the house for a long period.
- [ ] Only if the housing market is declining.
> **Explanation:** Paying for discount points is usually beneficial for those intending to stay in their home for a long time.
### What generally happens to monthly mortgage payments when discount points are paid?
- [x] Monthly payments decrease.
- [ ] Monthly payments increase.
- [ ] Monthly payments remain the same.
- [ ] Monthly payments fluctuate each month.
> **Explanation:** Monthly payments decrease due to the lower interest rate achieved by paying discount points.
### Can discount points be financed into the loan amount?
- [x] Yes, in some cases.
- [ ] No, never.
- [ ] Only for residential properties.
- [ ] Only for commercial properties.
> **Explanation:** In some cases, discount points can be financed into the overall loan amount.
### Why are discount points often paid at the time of loan origination?
- [x] To secure a lower interest rate.
- [ ] To expedite loan processing.
- [ ] To enable higher loan amounts.
- [ ] To lengthen the repayment period.
> **Explanation:** Discount points are paid upfront at loan origination to secure a lower interest rate on the mortgage.
### What is the main factor to consider when deciding to pay discount points?
- [ ] Market conditions only.
- [x] How long you plan to stay in the home.
- [ ] The age of the property.
- [ ] The size of the property.
> **Explanation:** The main factor is how long you plan to stay in the home, to ensure the cost of the points can be justified by future interest savings.
### Do discount points always lower the total cost of a loan?
- [ ] Yes, absolutely.
- [ ] No, they increase it.
- [x] It depends on individual situations.
- [ ] Only for fixed-rate mortgages.
> **Explanation:** While discount points typically lower the interest rate, whether they save money overall depends on how long you plan to stay in the property and other individual circumstances.
Thank you for diving deep into the concept of discount points. By thoroughly understanding their significance and functionality, you’re equipped to make more informed financial decisions in the real estate market.
