Discount Points and FHA Loans: What You Need to Know

Can you really lower your interest rate with points?

No points ban symbolWhen I was originating mortgages, my customers would often tell me that they did not want to pay points. My go-to question was always, "Do you know what points are?" However, they were aware that the points were an additional cost and usually said 'no.' So what are discount points?

Discount points are prepaid interest. If you are willing to prepay some of the loan interest at settlement, the lender is able to reduce your interest rate.

In this example, let's say that the loan amount is $100,000 and the interest rate is 4 percent. With a monthly payment of $477.42 and an interest cost of $71,869.51, the total cost of the loan over 30 years is $71,869.51. (principal and interest).

Let us now examine the loan with a single discount point applied. 1% of the mortgage amount equals $1,000, and one point decreases the entire interest rate by nearly a quarter of a percentage point.

If you are willing to pay one point under this example, the total interest paid over the life of the loan would be $66,721.61 and the monthly payment would be $463.12.

If this borrower paid one discount point, how much money would he or she save?

Loan Amount Interest Rate Total Interest Monthly Payment
$100,000 4.00% $71,869.51 $477.42
One Point 3.75% $66,721.61 $463.12
Difference 0.25% $5,147.90 $14.30

From this example, the borrower pays an additional point ($1,000) at settlement, but reduces the total amount of interest in $5,147.90 and lowers the monthly loan payment by $14.30.

Rotating question markFrequently Asked Questions (FAQs)

Q. Can I roll points into my refinance?
A. Most refinancing loans allow you to add mortgage points to your new loan, but bear in mind that this will increase the total amount of your new loan.

Q. Do you have to pay mortgage points out of pocket?
A. On purchase transactions, discount points are usually paid by the buyer however, the discount points may be paid by the seller, provided the cost of the points meet the seller paid closing cost limits.

Q. How are discount points on loans calculated?
A. Multiply the loan amount by the discount point percentage.

Q. What is the maximum number of discount points that you may purchase?
A. There will be a total of three discount points offered by lenders. Three points is the point at which the savings begin to diminish.

Q. Can you buy down points on an FHA loan?
A. Yes, you can buy down points on an FHA loan. This will lower your interest rate and monthly payment.

Q. Does the seller pay points on an FHA loan?
A. Home sellers are permitted by the FHA to pay discount points on behalf of the home buyer, however, the seller is not required to pay discount points.

Q. What is the purpose of the discount points on a loan?
The purpose of the discount points on a loan is to reduce the interest rate on the loan. The more discount points you pay, the lower the interest rate will be.

Conclusion

In conclusion, discount points and FHA loans are a great way to save money on your mortgage. By understanding the benefits and drawbacks of each, you can make an informed decision about which option is best for you. If you're looking to buy a home, be sure to consult with a lender to see if discount points or an FHA loan is the right choice for you.