This is a huge question – and the answer is, “usually not.”
(Did you watch until the end to see the bloopers? LOL)
Firstly, let’s define the important terms: “Discount fees” or “discount points” are the costs that a mortgage lender will charge in return for a specific interest rate. It’s usually expressed as a percentage of the loan amount or a flat dollar amount. What’s going on is that the lender will offer a lower interest rate in return for more money paid upfront.
The question is this: does it make sense to pay these upfront costs in return for a lower monthly payment?
As the video explains, it usually takes years for there to be a payoff. In other words, save your up-front money and make a slightly higher payment.
An additional option offered are what are known as “negative discount fees/points” or a “lender credit.” In this case, in return for taking an even higher monthly payment, the lender will give you some money that can in turn be applied against other closing costs. The higher the rate (and payment), the greater the lender credit. Although the math doesn’t work out quite as well in these cases, when compared to paying points to get the lower rate, it still takes years for the gain to be eliminated.
Bottom line: take the higher rate and the lender’s money. It’ll be a long time before that decision starts to hurt you!
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Well hi there, I’m Michael Hausam of the Hausam Group at Vista Pacific Realty.
So today I’d like to help you answer a very popular question and that is, “Should I pay discount points to buy down a mortgage interest rate?”
It’s a question that comes up on almost every single refinance and definitely every single purchase transaction; but first we need to do a little bit of education and background on interest rates and costs and lenders; so I’m going to show you a chart here in a second that was the screenshot from this morning’s interest rates and it’s going to show about 1/3 of the lenders that I work with.
This shows the menu of lenders this morning who were offering an interest rate of 4.5% on a 30-year loan at the Fannie Mae/Freddie Mac maximum loan amount of 679,650. It also shows what each lender is charging for that particular rate. We will pick the lender at the top, Freedom Mortgage, who this morning had the best price for this rate.
Now another thing to know about interest rates is that every single lender changes their rates every single day, so this morning Freedom Mortgage was at the top, at 4.5%, but tomorrow it could be any number of the 75 lenders we work with. And also just because Freedom was the best price at 4.5%, doesn’t mean that they were the best price at 4 1/4% or a 4.75%. It could have been another lender altogether.
This chart shows the pricing for all of the rates offered by Freedom Mortgage this morning, ranging from 4% up to 5.75%. For the sake of our discussion, we are going to pick the ones at 4.25%, 4.5%, 4.75%.
Now another term that I needed to define is discount points. You’ll hear that: discount fee, discounted cost, discount points; it’s all the same thing and it’s basically the money the price that the lender charges for a specific interest rate, usually expressed as a percentage of the loan amount or a flat dollar amount.
Now it also can be expressed as a negative number, a negative discount point, or a lender credit.
So the way that would work is that at a really low interest rate you would have to pay something – a discount point or a discount fee – and then at a higher interest-rate the lender will actually give you money back, that you can usually use as a credit for closing costs.
So the question is what is the better way to go? And the answer is: “It depends.“
This chart shows the interest-rate, the discount costs, the dollar costs, and the monthly payment on a $679,650 loan at 4.25%. The discount fee is 1.24% of the loan amount, or $8,318.92, and the monthly payment at 4.25% is $300,343.00 at 4.5% there’s a very slight credit of 0.116%, which is $788.39, the monthly payment at 4.5% is $100 higher at $3,343.00. At 4.75%, it’s a larger credit of 1. 174% of the loan amount, which amounts to a lender credit of $7,979.90 and for that the payment is $102 a month higher.
Now for this discussion, I am using the maximum Fannie Mae Freddie Mac loan amount in Orange County of $679,650, but the mathematics and the percentages and the payments work out exactly the same, comparing whether it’s $179,000 mortgage, a $1,079,000 mortgage, or a $5,079,000 mortgage; so keep that in mind, that whatever comparison and discussion we have, it’s the same for any loan amount that you get.
At 4.25% versus 4.5%, it’s $100 difference in payment, but at 4.25% you have a little over $8300 in costs whereas at 4.5% you get a lender credit of $788; eight total of $9100 difference in cost. Well, if you take that $9100 and divided by the hundred dollars a month difference in payment, it takes 91 months to get that payback.
In other words if you paid $9100 out of your pocket to drop the interest-rate from 4.5% down to 4.25%, $9100, that hundred dollars a month in monthly payment that you would save would take you 91 months before you broke even. Meaning it’s not until your 92nd month that you would actually start to make money.
Now let’s compare the payback. For 4.5% versus 4.75%, which was $102 difference in monthly payment. At 4.5%, there’s a $788 credit; at 4.75% it’s just over $7979. Again if you take the difference, which is $7190 and divide that by $102 and monthly payment savings, it’s a 70 1/2 month pay back.
In other words, if you took the $7100 from the lender and went from 4.5% up to 4.75%, you’d be saving money at a rate of $102 a month for 70.5 months. That’s almost 7 years of savings. It’s not until after that the monthly payment wipes out all the gains that you had upfront.
So what’s the better way to go? Again, it depends.
Obviously, on a straight dollar for dollar basis, it’s better to take the higher interest-rate and the lender credit than to pay all those costs upfront for the lower monthly payment. I mean you’ve got 7 to 8 or 9 years out in the future before the impact of that decision is made, but some people are so focused on having the lowest monthly payment that they’d prefer in their mind to think money savings on a monthly basis as opposed to saving all the money upfront.
Another option is, and this happens occasionally, if somebody’s getting relocated from another part of the country and their company is paying their closing costs; well, if it’s not your dollars that are paying for the lower interest-rate, take the lower interest rate!
And then lastly, there is a creative way that you can play with us, as well, and that is you can include it in the purchase price. If you pay a certain number of dollars more for the house but have the seller credit you back for closing costs, then you apply those closing costs to the monthly payment and that actually could potentially save you more money.
In other words, just using these numbers for example, if you paid $9000 more for the house and you have $102 a month less in monthly payment, that’s a far better way to go. I can help you figure out, and your specific situation, what’s the best way to go. ‘
So if you need to buy a house, seller house, or finance the house, please get it touch with me. It would be my privilege to help you.
You can call me at 949-413-2371.
You can email me Michael@hausamgroup.com.
Or if you click-should be a little button right above my head-here… If you click that, that will take you to my website and there’s ways on there that you can get a hold of me as well.
Thanks so much for listening. Have a great afternoon!