How It Works, Your Mortgage File

Discount Points

When shopping for a mortgage, you run across the term ‘discount point’.

What is that?

What does it mean to you?

First off, a point is one percent. Typically, it’s one percent of the loan amount and refers to a charge. . So focus on the word preceding ‘point’.  In this case, it is discount.

 

A discount is a reference to interest. 

To fully understand this concept, you need to know that banks and credit unions earn a profit by selling your loan on the secondary market. This profit is based on the interest rate they give you. The higher the rate, the higher the profit.

On any given day, a specific rate is worth a specific premium.  That premium is tied closely to the bond market which is why it fluctuates constantly.

Competition among banks keeps them from charging you an outrageous rate. Your ability to shop keeps them in check.

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EXAMPLE

Let’s suppose a rate of 3.5% earns your bank 1% on a loan amount of $100,000, a profit of $1,000. But, you want 3.25%.  The premium on 3.25% only earns your bank half a percent (.5%), or $500.  Your bank must make a certain amount to pay the bills and, in this case, $500 doesn’t cut it. Ordinary, they wouldn’t offer you 3.25%.

Now, let’s suggest that your bank wants to lure you in by advertising a rate lower than the competition. While everyone is offering 3.5%, they will offer you 3.25%,.  Sounds great!

However, we know they can’t make enough money at 3.25%.  What to do?

They are going to charge you the difference — one half percent, or $500 — and they are going to call it a discount point

Make sense?

Don’t assume the lender with the lower rate has the better deal.

On the other hand, as a savvy consumer, you might understand this concept and approach your lender asking for 3.25% while expecting the discount point. You also have calculated the cost and it appears as though paying the extra money upfront will profit you in the long term.

I hope this information will allow you to cut through marketing campaigns as well as allow you to make the best choice for you!

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