The Truth Behind Points, Part III

The Difference Between Origination Points and Discount Points

ORIGINATION POINTS

We have already discussed Origination points extensively in the previous two posts on this topic.

Discount Points, like Origination Points, run in increments of .125’s (1/8's).

But unlike Origination points, Discount Points are used to "Buy the Rate".

We discussed previously how rate is tied to broker pricing/income. Discount Points are used to buy the rate of a loan to a place that is BELOW the buy-rate a broker or lender offers. With Discount Points, you can obtain a rate that otherwise represents a COST to the broker, as opposed to a rebate (income) to the broker.

In a nut shell:

Since we know that Secondary Marketing sets pricing for the Correspondents, Lenders and Brokers, we know that Secondary sets rates, together with the rebate associated with a particular rate, every day. Most lenders show pricing that is both above (rebate, or income) and below (cost to broker) on their rate sheets every day. So, extrapolating the rate grid we used earlier, the full rate sheet might look something like this:

4.875% - 98.5 (cost to broker of 1.5%)
5.0% - 99 (cost to broker of 1%)
5.125% - 99.5 (cost to broker of .5%)
5.250% - PAR (neither a cost nor a rebate)
5.375% - 100.500 Rebate
5.500% - 101.000 Rebate
5.625% - 101.500 Rebate
5.750% - 102.000 Rebate
5.875% - 102.500 Rebate
6.000% - 102.875 Rebate
6.125% - 103.250 Rebate

If you think about this for a moment, you'll notice that you CAN buy a rate that is lower than the broker's buy rate. But you'll also notice that will COST you .5% . So if we think of that ficticious $100,000 loan again for a moment, you'll notice that it will COST .5%, or $500 to buy your rate down by .125% (an eighth), to a rate that is below what the broker can make money on. It's up to you, the borrower, to determine if this investment is wise for you; it'll cost you $500 on the front of the transaction to have the opportunity to save .125 in note rate.

The numbers: the P+I on $100,000 at 5.25% is 552.20. The P+I on $100,000 at 5.125% is 544.49. You save $7.71 per monthly payment. It will cost you $500 to get that monthly savings. It will take you 64.85 months to see a financial benefit from doing this. If you won't be in that home that long, or in that mortgage that long, you're wasting your money.

As you are no doubt aware, the spreads, rates, and buydown ratios change all the time. A good mortgage broker should be willing to sit down with you and help you determine the best strategy for dealing with discount points as they relate to your payment, and to your long-term strategies.

Note also that as you think about Discount Points, you should realize (and it may or may not be obvious) that when your rate is a COST to the broker, you will have to pay that cost, in closing costs. In addition, the broker office will still be expecting to make its customary 3% in origination. On the settlement statements, you'll see two line items:

line 801: Loan Origination Fee: ____________ (this will be a dollar figure, representing the broker office income)

line 802: Loan Discount: _____________ (this will be the dollar figure that is charged to you as a closing cost, buying the rate down)

A broker will never be allowed (by RESPA - the Real Estate Settlement Procedures Act) to collect lender-paid compensation, or REBATE, when there is also a discount fee to BUY rate. Therefore, the entire office income will be derived from line 801 on the settlement statement.

Also, Discount Points on line 802 of the settlement statement are the only items in this real estate transaction that are TAX DEDUCTIBLE for you. So that's another benefit to weigh out when you are thinking about your long term strategy.