What Are "Discount" Points?

Be careful when you answer because you may not exactly know the full answer. As an agent it is something you hear and something you learn about in CE classes from time to time but do you know exactly how they are determined? You will in five minutes. Some of you already do so you may be excused to continue Rain surfing but thanks for stopping in! There are also several readers who are not in the industry and really want and need to know this answer!

When you hear "discount" you automatically think of "something for sale which can be purchased for less than the normal price" right? That is exactly what we have come to know and understand as a discount. In the lending industry it is slightly different. There is a price for the discount - in other words the discount is created because the borrower (or seller or loan officer or real estate agent) buys something down from the "retail" price.

Have you ever wondered why some lenders advertise rates for (total examples so chill) 6.5% but one advertises for 5.75% for the "same loan"? Apparently there is some sort of a discount - to the interest rate. How could it be that one lender could offer an interest rate almost a full interest percent lower than all the others? Chances are it requires a "discount" to be purchased to "buy the rate down". This is not always in the borrower's best interest but can be. I really like to use refinance proceeds to "buy the rate down" when it is possible if the borrower (home owner) intends to keep that loan for at least several months before paying it off or refinancing.

Now here's where it gets a little tricky and I would wager that even 60% or more of "loan officers" (even some who are occasionally in the newspaper, on the radio or on TV) do not fully understand. Leave it to me to educate them because maybe, just maybe, it will improve my industry and the economy in some minuscule way for the nation and in some huge way for their next borrower. If I ask how much does it cost to buy down an interest rate one-half of a percent - how do you answer?

Most people, agents and loan officers included, will say .5% of the loan amount - but they would be wrong. Let's do the math that way. Let's say the PAR rate is 5% but you want a 4.5% rate. Now let's say, for math's sake, the loan amount is an even $200,000 and you fully qualify for that loan at that rate. Obviously the rate difference is .5% or 1/2 point. The common thought would be that you would need to pay .5% of the loan amount to buy that rate down. Anyone with a calculator or math brain can quickly deduce you would need to pay $1000 if you need to pay .5% of the loan amount to buy the rate down .5% - you would be incorrect.

Interest rates are established by the amount note buyers (mortgage investors) are willing to pay for a specific loan time at a specific interest rate. To buy the rate down using a discount you need to pay the difference between what the investor is willing to pay for the mortgage at par (5%) and how much they are willing to pay at the discount rate (4.5%).

Mortgage interest rate sheets can be fairly complex. I enjoy letting students see rate sheets for the very first time. I intentionally find the most obfuscated sheets just to prove my point about what makes interest rates so different based on so many qualifying factors.

Pictured is a snapshot from an actual rate sheet from earlier today on a 15 year Freddie Mac loan. We'll be using only the 30 day lock column (maybe I'll address locks later if enough of you ask about them) and we'll be buying the rate down to 4.5% from 5%.

The first thing you will notice is some of the numbers are in parenthesis and red. That is the amount that is rebated back to the loan officer as a commissionable revenue. (This is only divulged at mortgage brokers, mortgage bankers and lenders can hide this from you). On a 30 day lock the rebate amount is .713% of the loan amount ($200,000) so in this case $1426. If you were dealing with me you would have the choice of me getting this as a rebate or you paying it as part of the other fees out of pocket. (More on that later if enough of you ask about it - NOBODY works for free.)

Now, we want to get your rate to 4.5% and let's just say you are paying all your fees up front so I don't need that rebate from the lender anyway. The number in the 30 day lock column where it intersects with 4.5% is how much? Right 1.000 which means exactly 1% of .... the loan amount. So while the actual difference between 5% and 4.5% is .267% it is going to cost you a full 1% to buy your rate down .5% - confused?

Okay, the difference between 5% and 4.5% is determined this way: At 5% there is a .713 rebate but at 4.5% the loan costs (somebody other than the lender) 1% - if we subtract .713 from 1.000 we get .267 which is what the occasional untrained loan officer thinks. The truth is the cost difference between 5% and 4.5% is 1.713% but since you're not paying a retail rate with .713% going to the loan officer the discount costs you only the rate buydown price of 1% - you can NOT negotiate this price with the loan officer. If you want 4.5% you are going to pay a 1% discount, not a .5% discount as the vast majority of real estate agents would advise.

If you have questions and you are in the southeast and you really need a loan but your loan officer has no idea how to explain discounts to you you're probably not dealing with a highly knowledgeable mortgage banker. That's what I do for a living and I take my job very seriously. Call me for a quick application and I will show you why calling me is the best choice you can make for yourself, your family and your future.

Ken Cook - Novation Mortgage 678-946-0101 Georgia Home Loan Professional, Trainer and Lender