Getting a mortgage is a bit like an adventure. You start off not exactly sure what challenges you face, needing the help of a trusted friend to give you valuable advice, and (hopefully) arrive a few weeks later having secured victory – a new home for you and your family. Throughout the process (and by checking out these helpful articles) you’ll learn about industry terminology that is critical in understand. If you want to know determine your creditworthiness, you'll need to know phrases like “debt-to-income ratio”, which is your total debt load versus your pre-tax income.
You'll also need to know what “loan-to-value” means, which is the value of the home you’re buying or refinancing compared to your mortgage loan principal. If you're wanting to determine how much your monthly mortgage payment will be, you should become familiar with the term “discount points”. Buying discount points (or points, for short) can play a huge role in determining your monthly payment and fully-amortized balance. At some point during the process, the topic of points will come up, and it is crucial to have a good understanding of what they are, and when it makes sense to buy them.
Simply put, a discount point is 1% of your loan total – so if your mortgage is for $200,000, then each point is $2,000. Your mortgage loan originator should show you a few scenarios after checking your credit, and that’s likely to include an option to buy down your mortgage rate by purchasing a point or two. As it is explained in this CNBC article, you are essentially trading cash now for a lower monthly payment and a lower overall balance. In the example, a borrower can buy a point and shave 0.25% off their rate, saving them in both principal and interest each month. Sounds like a great idea, right? Wait! Before you jump into forking over your hard-earned cash up-front, ask yourself how long you plan to stay in your home. Typically, it takes 5-10 years to break even when you buy points, so if you are not sure where you’ll be in five years, then you might be better served lowering your rate with an adjustable-rate mortgage (more on that next week). However, if you’re planting roots in a community and plan to be in your home for the long term, buying points is a great way to save thousands of dollars each year for the next 15 or 30 years.
Don’t forget to do your shopping! Not every lender has the same offerings and options, so get a quote from a few lenders and do some comparisons to make sure you get the best rate and the best deal for you and your specific financial situation and needs.