Discount Points (for a Mortgage)

Discount Points (for a Mortgage)

in this video we're gonna talk about discount points when obtaining a mortgage so discount points are essentially prepaid interest that you give to the lender and I just want to clarify that we're not talking about any points paid on loan origination in this video that's something separate what I'm talking about is prepaid interest and the way it would be calculated is for example one point so if you offer one point to the lender you're basically giving one percent of the loans value all right so one percent of loan value so let's say it was a hundred thousand dollar loan you're offering to pay the lender one thousand dollars up front now that does not go toward the principle it's just based on the principle that we calculated just a percentage of the principal but it's actually prepaid interest now in exchange so what you might be wondering why would I prepay interest why is this why is this beneficial for me to do in exchange for this this one point for example the lender will give you a reduction in your interest rate so you'd get like a for example a zero point two five percent reduction in your interest rate so let's say that your interest rate was six point seven five percent with no points and you say you know what I'll give you one point you're giving the lender a thousand dollars and in exchange your rate is gonna go to six point five percent for the life alone so that's what discount points are might be a little easier for you to understand if we walk through an example and you can kind of see how it how it will play out so let's say that you have on the table you're ready to buy a home you've got a 30-year mortgage for 160 160 thousand dollars this the amount of the loan that's the loan value and it's seven percent interest the lender has quoted you now the lender says look I'll reduce this interest rate this seven percent interest rate by zero point two five percent per discount point so now let's say that you're saying okay you know I could offer one discount point I could offer to and so forth let's just say for the sake of this example let's say that you offer to discount points so let's say to discount points and then let's just take a look at how we would calculate that and how it would affect the loan so first off I probably should have noted here so that for these terms for a 30-year mortgage a hundred and sixty thousand at 7% interest you would have a monthly payment and this is rounded of one thousand sixty four dollars a month so this would be your monthly payment that's gonna come in handy momentarily so right now so let's say there's two discount points how do we calculate what we're paying the lender because it's prepaid interest right so we have to make a payment to the lender up front so what we do is this these two discount points we're gonna say right here that will be 2% because there's two points right if it was one point it would be one percent two percent and then we're gonna multiply that by the loan and so a hundred and sixty thousand dollars so two percent times a hundred and sixty thousand dollars and what is that going to give us change colors here that's gonna give us 32 hundred dollars so we're going to prepay assuming that we do this we're gonna prepay $3,200 to the lender want to make sure this is click now again this is not saying oh okay well now we owe you know 160,000 minus thirty-two hundred that's not how it works right this is not reducing the the principal all right so this is this is interest is not affecting the loan balance so this is what we're doing for the lender now what is the lender doing for us well they're gonna reduce our rate by 0.25 percent per discount point right now we're giving them two points so that means two times 0.25 percent and so what is that gonna be it's gonna be half a person so our interest rate is gonna go from 7% and now we're gonna have an interest rate of 6.5% and I'll just put here that's our new interest rate now we can go ahead and calculate a new monthly payment and the reason for that let me just go so now up here we have enough information to calculate our monthly payment and we calculated a thousand sixty four right what our interest rate has changed so one of the inputs to calculating the monthly payment has changed so now because we have a lower interest rate we're gonna have a lower monthly payment so now let's let's see how much so our new insert our new monthly payment so I'll put your monthly payment is going to be and I'm just I just rounded this 1011 dollars a month all right so that's that's the new payment now you see if we go back to our other payment we've got a thousand sixty four versus a thousand eleven so there's a difference of fifty three dollars there so put it this way we're paying thirty two hundred dollars upfront to save fifty three to fifty three dollars a month so how will we go let's see I just really want to make sure this is clear so let me change colors again pay 3,200 upfront to save fifty three dollars a month so if we want to say is this a good deal for us should we give the lender the two discount points or should we say no we don't want to do that well there's a really simple way that we can calculate whether this is going to be beneficial to this because it's gonna depend on how long we decide to hold this it should own the home right if we decide we want to sell or refinance that's gonna change things right and I'm gonna explain why momentarily but just say okay so we're paying 3,200 but we're benefiting 53 dollars a month so if we take that 3,200 that's being paid and we divide it by fifty three dollars a month that's gonna tell us how many months that it's going to be before we break even right so I'll even just put that here months to break even and by break even I've seen worse we're indifferent whether we'd lose money or gain money so we need we could figure out how many months we would have to have this loan before we'd actually you know break even and then after that month we start to actually make money and it'd be a good deal for us so if you take 3200 and divide it by fifty three dollars a month you're gonna get sixty one months that's actually it's like sixty points something but if you did sixty months then you'd be losing money so you have to do it this the sixty first month is when we break even at that point now so then let me just say in 61 months and you might think of that as five years five years and one month that might be a little easier for you to think about it like that so if we take out this loan to buy this house and we give the lender two points we're paying them thirty two hundred dollars up front to get a cheaper monthly payment of fifty fifty three dollars cheaper and if we own this house for longer than five years in one month that will become a good deal for us right because at that point the savings have accumulated enough right so if you if you think about it for example if we multiply this 53 by let's say a hundred months right so then we'd have this is just an example so let's say here with me make sure to make this really crystal clear for you so we had fifty three dollars a month that you save and then let's say it was multiplied by a hundred months which is greater than the sixty one that we're talking about you're just trying to make it easier if you understand that would be that we say our $5,300 right so then you just think about it like this well we paid thirty two hundred and assuming you're gonna hold this for a hundred months your city then that's fifty three hundred so fifty three hundred is larger than 32 hundred right so basically this point right here the 61 months that's the point where okay if we plan to own this home at least this long then it would be advantageous for us to pay the points however if you are thinking you know what I think I'm gonna sell this house in two years I don't plan on living here that long or I might want to refinance in that case there's thirty two hundred dollars that you're paying up front is not enough that you're not that this fifty three dollar a month savings is not compensating for the amount of money that you're giving to the lender up

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