One of the qualify criteria the lenders scrutinize is the loan applicant's "Debt to Income Ratio", or total debt payments divided by gross income. Most banks do not allow borrowers to take on combine housing expenses of over 40% of the borrower's gross income. When a borrower's Debt to Income Ratio is a higher than what the lender allows, mortgage brokers often suggest to have the borrower pay some discount points to buy down the interest rate, the borrower in turn would have a lower mortgage payment and fall within the allowable housing expense ratio.
If you plan on living in your home for a longer period of time paying discount points to have a lower interest rate can be a great advantage.
Depending on the loan amount, the discount point to interest rate buy-down ratio, how long will the borrower keep the mortgage, the borrower's cash position, in some cases, paying a several thousand dollars in discount points to buy down the interest rate can save the homeowner tens of thousands of dollars over the life of the mortgage.
When paying discount points one has to understand the difference between cost and price. When a loan is amortized over the 30 year period the total payment for the loan is the cost. You have to reffer to a amortization schedule to understand how much the loan will cost over the term of the loan. When paying points (lower price) to buy down a rate you are saving money (lower cost) over the life of the loan.
Homeowners who are "cash rich and income poor" often choose to pay discount points to buy down the interest rate. With a lower interest rate, these homeowners can often qualify for a mortgage loan amount that he would otherwise not qualify with his income.
If you only plan on staying in the property for a few short years then it might be to your advantage to not pay discount points and go with the higher rate. Seeing the difference on a spread sheet or using a financial calculator will help you make the decision that is right for you.
Points, sometimes referred to as Discount Points are different than origination fees, and are a source of confusion for many borrowers. Although "points" are a part of your closing costs, they are not considered loan fees. They are an optional way to buy the interest rate up or down. Interest rates are generally quoted in increments of eighths. Usually, the lower the interest rate, the more points you will be required to pay.
Discount points are considered "pre-paid" interests, interests paid before money is owed. Pre-paid interests, like most clsosing costs, are tax deductible. Always consult a tax professional before taking such deductions.
Paying a discount point or points in order to lower the interest rate when refinancing into a long term fixed rate mortgage often makes good sense. The discount points can usually be financed into the loan.
Even with a higher loan principal to cover the points, the borrowers monthly payment is usually lower due to the lower rate of interest charged.
The discount point is pre-paid interest so you should know how long you will be in your home to see if it makes sense for you. The longer you will be in your home the more you will realize a greater savings.