Unless you have been in the mortgage market for a while, you may not understand the concept of discount points. Points are upfront fees paid to the lender that induces them to lower the interest rate on a loan. Points will lower your total interest rate, and therefore the monthly payment on your loan.
One point equals 1% of the loan, and it is paid to the lender at the loan closing. If you are obtaining a $200,000 mortgage, one point would cost you $2,000 at closing. The more points you are willing and able to pay, the lower the rate on your mortgage will be.
Your mortgage loan rate is determined primarily by your credit worthiness, but whatever the rate on the loan, paying points will bring it down. A buyer who was quoted 6% based on his credit rating, will receive a series of different quotes based on points. There is no set amount, but most lenders will lower a fixed rate loan by .25% and an adjustable rate loan by .375% for each point paid. If we use the $200,000 loan in the above example, and we pay one point, we can reduce the rate to 5.75% on a fixed rate and 5.625% on an adjustable rate loan.
Most loan quotes are automatically offered with the point quote. For example, the lender may list the rate as 6%, no points, 5.75%, one point, 5.5%, two points, etc. Next you would see 7%, with the accompanying rate reductions per point, and so on for each rate. So it is important to realize what the rate you will pay without points is to be able to find the rate you will have with points.
The monthly loan payment is lowered with each lowering of the rate; clearly a loan with a rate of 5.75% is going to be cheaper than a loan with a 6% rate. This sounds like it would always be a good investment, but you have to keep in mind that you are basically paying interest up front. This is why it is important to examine points with a view to how long you plan on living in the home. In other words, you need to amortize the payment amount for the points over how long you plan to have the loan.
Since a home buyer is going to have a lower loan payment, this will mean that he can afford to pay more for a home. A seller may advertise “seller pays points” to bring in more buyers. But this doesn’t change the initial calculations, because the price of the home will reflect the seller’s contribution.
Borrowers do not have to pay points, they do it if they are interested in lowering the rate. It is merely a decision to lower the interest rate of the mortgage.
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