Buying Down Interest Rates With Discount Points On Mortgage

In this blog, we will cover and discuss buying down interest rates with discount points on mortgage loans. Lenders will charge higher mortgage rates to those seeking a home loan with bad credit, especially for conventional mortgage programs. Conventional mortgage programs are extremely credit-sensitive.

Credit Scores Versus Pricing on Mortgage Rates

The minimum credit score required for borrowers to qualify for conventional loans is a 620 credit score. A 620 credit score is considered a very low credit score for conventional loans. Borrowers with a 620 credit score will most likely get penalized with a high mortgage rate. To get the best possible conventional mortgage rates borrowers need to have a credit score of higher than 740.

Do You Want to Learn More About Buying Down Interest Rates With Discount Points On Mortgage?

Loan Level Pricing Adjustments On Credit Scores

Every 20 point drop from the 740 credit score will have an adjustment which means a higher rate for every 20 point drop in credit scores:

For example, if par rates on a conventional mortgage loan was 4.5% with 740 credit scores:

• the rates might be 4.625% with a 740 credit score
• 4.75% with a 720 credit score
• 4.875% with a 700 credit score
• 5.0% with a 680 credit score
• 5.125% with a 660 credit score
• 5.25% with a 640 credit score
• 5.5% with a 620 credit score
• Please do not quote me on the above rates

The above rates are just used for illustration purposes.

Benefits of Buying Down Interest Rates

Buying down interest rates with discount points on a mortgage can benefit borrowers. Discount points are prepaid interest you can pay upfront to lower your mortgage interest rate. Here are the benefits of using discount points to buy down your mortgage rate:

• Lower Monthly Payments: You can reduce your mortgage interest rate by paying discount points upfront. A decreased interest rate leads to smaller monthly mortgage payments, which can enhance the affordability of homeownership.
• Long-Term Savings: Over the life of your mortgage, a lowered interest rate can result in substantial cost savings. Even a small reduction in the interest rate can translate into substantial savings over the years.
• Tax Deductions: In certain instances, it is possible to claim deductions for the cost of discount points on your income taxes, which can further reduce the overall cost of homeownership.
• Improved Affordability: Reduced monthly payments can simplify the mortgage qualification process and enable individuals to afford higher-priced homes, which can be particularly advantageous for first-time homebuyers or individuals with limited budgets.
• Faster Equity Buildup: With a diminished interest rate, a larger share of your monthly mortgage payment is allocated to reducing the principal balance of your loan. This can accelerate the accumulation of home equity.
• Fixed-Rate Stability: If you opt for a fixed-rate mortgage, buying down the interest rate with discount points can provide stability by locking in a lower rate for the entire term of your loan. This protection can be valuable if interest rates rise in the future.
• Peace of Mind: Knowing that you have secured a lower interest rate can provide peace of mind, as it reduces the risk of future interest rate increases and higher monthly payments.

It’s important to note that the benefits of buying down interest rates with discount points may fluctuate based on your unique financial circumstances, the current interest rate environment, and your long-term homeownership goals. Before purchasing discount points, calculate whether the potential long-term savings justify the upfront cost. Also, consult a mortgage professional to determine the best strategy for your circumstances.

Experience These Amazing Benefits of Buying Down Interest Rates. Click Here.

FHA Mortgage Rates With Bad Credit

FHA mortgage rates are not as sensitive to credit scores. Current FHA 30 year fixed mortgage rates for borrowers with credit scores of 640 or higher may be 4.25%. So whether credit scores are 640 or 740 your FHA mortgage rates will be 4.25%. However, those with lower than 640 scores may get charged price adjustments where mortgage rates may be higher. Those with credit scores under 600 scores may get much higher mortgage rates. Some lenders can charge mortgage rates higher than 5.0% for those with credit scores under 600 credit scores due to Loan Level Pricing Adjustments (LLPA).

Buying Down Interest Rates By Paying Points To Get Lower Rate

There are cases for borrowers who have high debt to income ratios where buying down mortgage interest rates is the only option to bring down the debt to income ratios. For example, borrowers who barely qualified with borderline debt to income ratios may no longer qualify for the mortgage if their insurance premiums are much more than expected. They may have options in seeking ways of reducing their monthly expenses such as the following:

• paying off credit cards
• paying other debts off like auto loans
• getting non-occupant co-borrowers
• buying mortgage interest rates by paying points

Buying Down Rates With Points To Lower Rates In Order To Meet DTI Cap Requirements

But after exhausting all possibilities and if borrowers’ debt to income ratios are still high, their only other option may be to buying down interest rates by paying points. For example, say a borrower with a 580 score is charged a mortgage rate of 5.625%. In order to meet the debt to income ratio cap, the borrower needs to be at a 5% mortgage rate. Lenders can charge 2% to 3% in buying down interest rates from 5.625% to the 5.0% mortgage rate. Points are not cheap and quite costly. Borrowers can use seller’s concessions towards buying down interest rates.

Fixed-Rate Mortgages

• Definition: A mortgage with a fixed interest rate for the entire loan term.
• Discount Points Impact: Purchasing discount points can permanently reduce the fixed interest rate, leading to lower monthly fees and overall interest savings over the life of the loan.
• Ideal For: Borrowers who plan to stay in their home long-term and want stable, predictable payments.

Adjustable-Rate Mortgages (ARMs)

• Definition: A mortgage with an interest amount that can change periodically based on the performance of a specific benchmark.
• Discount Points Impact: Discount points can lower the initial interest rate during the ARM’s fixed period. After the fixed period, the rate adjusts based on the index and margin.
• Ideal For: Borrowers who plan to move or refinance before the adjustable period begins and want lower initial payments.

FHA Loans

• Definition: Mortgages insured by the Federal Housing Administration, designed for low-to-moderate-income borrowers.
• Discount Points Impact: Unlike conventional loans, discount points can lower the interest rate. FHA loans also involve upfront mortgage insurance premiums (UFMIP) and annual mortgage insurance premiums (MIP).
• Ideal For: Borrowers with lower credit ratings and smaller down payments who still want the option to reduce their interest rate.

VA Loans

• Definition: Mortgages guaranteed by the Department of Veterans Affairs, available to eligible veterans, service members, and their families.
• Discount Points Impact: Discount points can be used to reduce the interest rate. VA loans usually do not need private mortgage insurance (PMI), but a funding fee may exist.
• Ideal For: Veterans and active-duty service members looking for competitive rates and no down payment.

USDA Loans

• Definition: Mortgages backed by the U.S. Department of Agriculture for approved rural and suburban homebuyers.
• Discount Points Impact: Discount points can lower the interest rate. USDA loans have income limits and geographic restrictions.
• Ideal For: Low-to-moderate income borrowers in eligible rural areas seeking low or no down payment options.

Jumbo Loans

• Definition: Mortgages that exceed the conforming loan limits set by the Federal Housing Finance Agency.
• Discount Points Impact: Borrowers can purchase discount points to lower the interest rate, similar to conforming loans. Jumbo loans often have stricter credit and income requirements.
• Ideal For: Borrowers purchasing high-value properties that exceed conforming loan limits.

Interest-Only Mortgages

• Definition: Mortgages where the borrower pays only the interest for a set period, followed by principal and interest payments.
• Discount Points Impact: Discount points can lower the interest rate during the interest-only period, potentially reducing monthly payments.
• Ideal For: Borrowers who expect a significant increase in wage or plan to sell or refinance before the principal payments begin.

Construction Loans

• Definition: Short-term loans used to finance the construction of a home, which convert to a permanent mortgage upon completion.
• Discount Points Impact: Discount points can lower the interest rate on the permanent mortgage once construction is complete.
• Ideal For: Borrowers building a custom home who want to lock in a lower rate for the permanent mortgage.

Balloon Mortgages

• Definition: Mortgages with lower initial payments and large balloon fees due at the end of the loan term.
• Discount Points Impact: Discount points can reduce the interest rate during the initial payment period.
• Ideal For: Borrowers who anticipate selling or refinancing before the balloon payment is due.

Conventional Loans

• Definition: Mortgages not insured or guaranteed by the federal government, typically conforming to Fannie Mae or Freddie Mac guidelines.
• Discount Points Impact: Purchasing discount points can lower the interest rate, reducing monthly payments and total interest paid over the life of the loan.
• Ideal For: Borrowers with outstanding credit and stable earnings looking for competitive interest rates and terms.

Each type of mortgage offers unique advantages and considerations when buying discount points. Understanding how discount points affect each loan type can assist borrowers in making well-informed choices tailored to their financial circumstances and long-term objectives.

Frequently Asked Questions (FAQs)

1. What are discount points?

Discount points are charges paid upfront to the lender at closing in return for a lower interest rate on your mortgage. Each point typically costs 1% of the total loan amount and can lower your interest rate by a certain percentage, often around 0.25%.

2. How do discount points work?

By purchasing discount points, you pay more upfront in closing costs to receive a lower interest rate over the life of the loan. This can result in significant savings on interest fees over time.

3. Are discount points tax-deductible?

Yes, discount points are usually tax-deductible as mortgage interest. Still, it is important to talk with a tax advisor to understand how this applies to your situation.

4. How many discount points can I buy?

The total number of discount points you can buy varies by lender. Still, typically, borrowers can buy between one and three points. Some lenders may allow for more, but it is best to discuss your options with your lender.

5. Should I buy discount points?

Deciding whether to buy discount points depends on several factors, including how long you plan to stay in the home, your financial situation, and current interest rates. If you plan to stay in the home for a long time, purchasing points can save you money.

6. How do I calculate the break-even point for discount points?

The break-even point is the time it takes to save from the reduced interest rate to equal the cost of the discount points. You can calculate it by dividing the points’ cost by the monthly interest savings. This will give you the number of months needed to break even.

7. Can I finance discount points?

You can sometimes finance discount points by including them in your loan amount. However, this will increase your loan balance and monthly payments, so weighing the pros and cons is important.

8. Are discount points available for all types of mortgages?

Yes, discount points can be purchased for most types of mortgages, including fixed-rate, adjustable-rate, FHA, VA, and USDA loans. However, the availability and terms can vary by lender and loan type.

9. How do discount points affect my monthly mortgage payment?

By lowering your interest rate, discount points reduce the interest you pay each month, resulting in lower monthly mortgage payments. The exact amount of savings depends on the number of points purchased and the original interest rate.

10. Can I buy discount points after closing?

No, discount points must be purchased at the time of closing. Once the loan is finalized, you cannot buy additional points to reduce your interest rate.

11. Are there any downsides to buying discount points?

The main downside is the upfront cost. Paying for discount points requires a larger cash outlay at closing, which may only be feasible for some borrowers. Additionally, suppose you sell or refinance the home before reaching the break-even point. In that case, you may not recoup the cost of the points.

12. How do I decide if buying discount points suits me?

Consider your financial goals, how long you plan to stay in the home, and your ability to pay the upfront cost. Use a mortgage calculator to compare scenarios and talk with your lender or financial advisor to make an informed decision.

Qualifying For Mortgage With Direct Lender With No Overlays

Home Buyers who need to qualify for a mortgage with a national direct lender with no mortgage lender overlays can contact us at Gustan Cho Associates at 800-900-8569 or text us for a faster response. Or  email us at gcho@gustancho.com. Gustan Cho Associates has zero overlays on government and conventional loans. Gustan Cho Associates empowered by NEXA Mortgage, LLC NMLS 1660690 is licensed in 48 states and has over 160 wholesale mortgage lenders. We have a reputation for being a one-stop mortgage shop. We are not just experts on government and conventional loans with no overlays but are experts on non-QM loans and bank statement loans for self-employed borrowers. We have hundreds of non-QM and alternative mortgage loan programs.