Unless you have been in the home loan market for some time, 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. When the rate is less, so will the monthly loan payment.

When lenders speak of a point, they mean 1% of the entire loan. For a $200,000 mortgage, one point would be $2,000. You can buy more than one point and reduce your loan rate proportionately.

The original interest rate on the loan will still be based on the credit score of the borrower, but paying points will bring that original rate down. A buyer who may have been quoted 6% based on his credit score, will receive a series of other quotes based on points. A general rule, but one that changes from one lender to another, is that one point will lower the mortgage rate .25% on a fixed rate loan and .375% on an adjustable rate loan. If we use the $200,000 mortgage 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.

If you inquire about a mortgage rate, you will most likely see the rate quoted along with points. In other words, the quote could be 6%, 5.75% (1 point), 5.5% (2 points), etc. On the next table, will be the quotes for 7%: 6.75% (1 point), 6.5% (2 points), etc. This is what makes it critical that a borrower know what the point system means.

Obviously, your loan payment is going to be lower on a loan with 5.75% or 5.625% than it will be on a loan with a 6% rate. What the borrower is effectively doing is paying some of the interest in advance. This is why it is important to look at points with a view to how long you plan on living in the home. You have to spread the cost of the points over the time you plan to live in the house.

Since a home buyer is going to have a lower loan payment, this usually means that he can afford to pay more for a house. This is why you may see homes advertised with an offer that the seller is offering to pay points. Even when this is the case, the buyer should make sure the investment is worthwhile and that he is going to be in the house long enough to make it so.

There is no obligation on the part of the buyer to pay points. It’s a decision that a borrower can examine depending on many of the other factors in the loan.

This entry was posted on Thursday, May 13th, 2010 at 8:28 am and is filed under Mortgage Loan Rates. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.