Mortgage 101: Discount Points and Lender Credits
The Difference Between Discount Points and Lender Credits
When it comes to mortgages, there are a lot of terms that can feel like alphabet soup when you are first getting started. There are terms and acronyms for what feels like everything. There have been multiple scenarios where I started a new job and veterans at the company would start sounding off acronyms. In my mind I was thinking, “Wait, what, this is my second week”. So, I will try not to be that person! Of all of those terms you may be introduced to, two of those terms that you will often hear in the same breath are “discount points” and “lender credits”. So, what is the difference between them? How do they impact your mortgage? The next two minutes of material will provide you an explanation of what these two terms mean and how they affect you as a homebuyer.
Discount Points: Discount points are used to buy down the interest rate on your loan, which can result in lower monthly payments over the life of the loan. These are paid upfront in exchange for a lower interest rate, meaning that you will pay less interest in total over time. Discount points typically cost 1% of your loan amount for every point purchased, so if you borrow $200,000 and purchase 2 points, it will cost you $4,000 up front. If you purchased 1 discount point for that same $200,000 loan, it would cost you $2,000 up front instead of the $4,000. Just note that most lenders only allow you to purchase up to 3 points.
Two main characteristics of discount points are that they reduce your interest rate by approximately 0.25% for each point purchased and it provides an immediate benefit of lower monthly payments with long-term savings throughout the life of your loan. So, if you do not plan on keeping the home for longer than two years, then it may not make sense for you to pay the additional upfront costs since the cost benefit of doing this is seen years down the road. The main pro of purchasing discount points is that you can save significantly on interest payments over time while a con is that you have to pay more at closing due to the upfront cost associated with purchasing discount points.
Lender Credits: Lender Credits are credits given by the lender to the borrower at closing. They are usually given in exchange for a higher interest rate, so it is possible to have less of a financial burden upfront by opting for lender credits. One pro of opting for lender credits is that they can reduce your out-of-pocket closing costs. However, the major con of lender credits is that you will pay more for interest over the life of the loan. Lender credits work similarly to discount points, but they operate in reverse. Lender credits reduce your up front cost required to close, but causes your monthly payments to increase since your interest on your loan amount is higher.
Knowing the difference between discount points and lender credits truly is an important part of getting a mortgage. Think about these two options acting similarly, but in an opposite manner. Both options can have benefits and drawbacks depending on your individual situation, so it is important to weigh both carefully before making a decision. In most cases, taking advantage of either option can be a good way to reduce costs when buying a home, so be sure to speak with your mortgage lender and see if they offer either of these options. With all that being said, understanding the basics of discount points and lender credits is the first step towards becoming an informed homebuyer. Always be ready to ask your lender these questions to ensure they are making decisions that are best aligned with your financial interests.
*This is not financial advice. For educational purposes only. Before making any financial decisions, consult with a professional.
