Want a lower interest rate on your FHA-insured mortgage loan? Consider paying points at closing. This one-time, upfront closing cost could give you access to a “discounted” rate, thereby saving you money over the long term.
But “long term” is the key phrase in that last sentence. Paying discount points on an FHA loan is something that tends to pay off after a number of years. It doesn’t work so well for a shorter stay.
Definition: A discount point is basically a lender credit that allows you to make a tradeoff in how you pay interest on your loan. One point is equal to one percent of the loan amount. Some borrowers choose to pay discount points up front, at the closing, in exchange for a lower mortgage rate on the loan. This strategy can be applied to both FHA and conventional home loans.
Note: There are other types of points and credits available to borrowers. This article focuses on the discount point in particular, which is the one borrowers sometimes use to secure a lower rate from the mortgage lender.
Paying Discounts to Get a Lower FHA Loan Rate
As mentioned above, paying discount points on an FHA loan is a tradeoff:
- You’re essentially paying more money up front, so that you might pay less money (in interest) over the long term.
- If you stay in the home and keep the loan long enough, the amount you save (from having a lower monthly payment) will eventually surpass the amount you paid for the point.
- The point at which your accumulated savings begin to surpass the amount paid in points is known as the break-even point. It’s sometimes spelled “breakeven point,” or with the acronym BEP.
How to Calculate the Break-Even Point
To recap, some borrowers pay discount points on their FHA loans in exchange for a lower mortgage rate from the lender. Over the long term, this strategy could save the borrower a significant amount of money by reducing the size of the monthly payments. It can also reduce the total amount of interest paid over the loan term.
But does it make sense for you?
To answer that question, you’ll need to calculate the break-even point (defined above) and think about how long you plan to keep the loan.
There’s a formula you can use the get a general idea of where the break-even point lies. If you divide the cost of the points by the amount you’ll save on your monthly payments, you’ll end up with the number of months you need to keep the loan in order to reach the break-even. Beyond, the break-even point is where you start to enjoy savings.
Here’s that formula again:
Cost of points ÷ Monthly payment savings = Months to reach break-even
What the Handbook Says About It
Borrowers can pay discount points on FHA loans (which are insured by the government), as well as conventional mortgage loans (that are not insured by the government).
When it comes to the rules and requirements for FHA-insured home loans, we must look to the Department of Housing and Urban Development, or HUD. (The Federal Housing Administration is part of HUD, so it’s HUD that establishes all of the program requirements.) Most of these guidelines are covered in HUD Handbook 4000.1, the Single-Family Housing Policy Handbook.
Here’s what that handbook says about discount points for FHA loans:
- “Discount Points refer to a charge from the Mortgagee for the interest rate chosen. They are paid by the Borrower and become part of the total cash required to close.”
- “Other Fees and Charges: The Mortgagee or sponsored TPO may charge the Borrower discount points, and lock-in and rate lock fees consistent with FHA and CFPB requirements.”
The handbook also states that “interested parties” in the transaction (like the seller, builder or developer) can “contribute up to 6 percent of the sales price toward the Borrower’s origination fees, other closing costs and discount points.”
So there you have it, a crash course in paying discount points for a lower interest rate on your FHA-insured mortgage loan. If you found this article helpful, you might want to peruse our collection of related articles available here.