Discount points

Key Takeaways

• One discount point equals one percent of the loan amount, so one point on a $400,000 loan costs $4,000 at closing.
• Discount points are a one-time up-front payment that lowers the interest rate on the mortgage for the life of the loan.
• Origination charges pay the lender for creating the loan and do not lower the rate, while discount points do lower the rate.
• Washington's Mortgage Broker Practices Act requires a written disclosure of the amount of points within three business days after a loan application, under RCW 19.146.030.

What It Means

Discount points are prepaid interest. A borrower hands the lender money at closing in exchange for a lower interest rate on the mortgage, and each point costs one percent of the loan amount. One point on a $350,000 loan is $3,500. Two points is $7,000.

Because the rate reduction runs for the life of the loan, points are a trade between cash today and a smaller payment every month afterward. The math turns on the break-even point, which is the number of months of payment savings it takes to earn back the cash spent at closing. A borrower who expects to sell or refinance before that break-even arrives usually loses money by buying points.

Points are not the lender's charge for the work of making the loan. That is what Origination Charges cover, and the two are itemized separately on the Loan Estimate and the Closing Disclosure. Points are optional and a borrower can decline them. Origination charges normally come with the loan whether the borrower wants them or not.

How It Works in Washington

Points on a Washington loan are shaped mostly by federal disclosure law, and the state layers its own rules on top through the Mortgage Broker Practices Act, chapter 19.146 RCW. RCW 19.146.030(1) requires a mortgage broker or loan originator to give the borrower a full written disclosure within three business days following receipt of a loan application, itemizing and explaining all fees and costs the borrower must pay. RCW 19.146.030(2)(a) sets the required contents, which include the annual percentage rate, the finance charge, the amount financed, and the amount of points or prepaid interest.

Washington also polices how points are advertised. RCW 19.146.0201(5) makes it a violation to solicit, advertise, or enter into a contract for specific interest rates, points, or other financing terms that are not available at the time of the solicitation, advertisement, or contract. A rate sheet promising a lower rate for one point has to reflect a price the originator can deliver.

For a real estate broker the practical rule is short. Quoting points is lender work, and RCW 18.86.050(1)(c) requires a buyer's agent to advise the buyer to seek expert advice on matters beyond the agent's expertise. Send the buyer to the loan originator for the numbers.

Example

Devon Marsh is buying a Tacoma townhouse with a $400,000 loan. His lender quotes 6.75 percent with no points, or 6.25 percent if he pays two discount points. Two points is two percent of $400,000, which is $8,000 due at closing.

At 6.75 percent his principal and interest payment on a 30 year loan is about $2,594. At 6.25 percent it is about $2,463. The lower rate saves him roughly $131 a month. Dividing the $8,000 cost by $131 in monthly savings gives a break-even of about 61 months, a little over five years. Devon expects a job transfer in three years, so he keeps the $8,000, takes the 6.75 percent rate, and puts the cash toward his Cash To Close.

Common Mistakes and Exam Traps

• A point is one percent of the loan amount, not one percent of the purchase price. Whenever the buyer makes a down payment those two numbers are different.
• Discount points lower the interest rate. Origination charges pay the lender for making the loan and do not change the rate.
• A point is not a percentage point of interest. Paying one point rarely drops the rate by a full one percent.
• Points are prepaid interest and show as a debit to the buyer on the settlement statement, unless the parties agree the seller will pay them as a concession.