Discount points are not an easy topic for many new borrowers. The basic explanation of paying discount points is that you are paying part of your interest to the bank in the beginning in order to lower your mortgage payments later on, during the course of the mortgage. When the rate is lowered, so will the monthly loan payment.
When lenders talk about a point, they mean 1% of the total loan. If you are obtaining a $200,000 mortgage, one point would be $2,000 at closing. A borrower has the choice of paying one or more points on the mortgage.
As anyone who has been shopping for a loan knows, one’s credit rating determines the loan rate, and then the point reduction is taken off this rate. For example, if the original rate quote is 6%, according to your credit score, ask how much it will be if you are willing to pay any points. A general rule, but one that can change from bank to bank, is that one point will lower the mortgage rate .25% on a fixed rate loan and .375% on an adjustable rate loan. In discussing our example of a $200,000 loan, above, let’s say we want one point, that is, to have the loan rate reduced to 5.75% of 5.635%, depending on whether it is fixed or adjustable.
Most banks will give mortgage interest rates with optional points alongside. For example, the lender may list the rate as 6%, no points, 5.75%, one point, 5.5%, two points, etc. Then the quote would show 7% with the pertinent reductions. 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.
It is clear that a monthly mortgage payment will be lower with a loan of 5.75% than with a loan of 6%, but you have to take into account the points. 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 look at points with a view to how long you think you’ll be living in the house. Paying points is only a good idea for those who plan on holding the loan for quite a while.
Since a home buyer is going to have a lower loan payment, this usually means that he can afford to pay more for a home. A seller may advertise “seller pays points” to bring in more buyers. But keep in mind that this may raise the price of the home by the amount of the points.
It is important to note that there is absolutely no obligation on behalf of the borrower to pay points. It is a completely voluntary decision based on his analysis of the costs involved.
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