Even though distinctions can be made, Points, Discount Points, and Origination Fees are effectively the same thing, and they are used interchangeably.
A “point” typically represents 1% of the loan amount. So, a 1/2 point is 1/2% of the loan amount, and so on.
Paying a full point will typically “buy down” an interest rate by about 1/4%, depending on market conditions.
Hence, it will take about 4 years to recoup that point.
But, that point is also tax-deductible in the year of the purchase, so the recoup period can technically be shorter when tax benefits are taken into account.
Why We Don’t Recommend Paying Points
We typically don’t recommend paying points because we think: (1) buyers get too little bang for their buck; (2) paying points depletes cash reserves; and (3) buyers often end up refinancing or selling long before they make up the points with their interest rate savings.
When Points Are Recommended And/Or Necessary
Sometimes points are necessary for a borrower to buy down her rate in order to lower debt ratios enough to qualify.
And – it might be smart to pay points to buy down a rate if borrowers are certain that rates will climb or remain high for many years and/or they are confident that they will stay in the home for many years.
Why We Really Dislike Points Now (Purpose Of This Blog)
We discourage points more than ever right now because we think a rate drop is so likely within the next 6 to 12 months – given the likelihood of a recession and other events (stock market correction, sovereign debt crises, etc.) that will likely bring rates down significantly.
And – when rates do drop significantly, borrowers will be able to refinance, at no cost in most cases, into lower rates – rendering the points they paid a total waste.
Watch Out For “Fake Discount Points”
Some lenders portray points as something that is necessary to buy down a rate, when they are already making an ample “rebate” or commission on the back end (obtained when they sell the loan).
I knew a loan officer who used to tell all of her clients that FHA required her to charge a point even though she always earned a 2% to 3% rebate on the back end.
I never played that game of course, and it is why JVM is still in business and she is not :).
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