Discount points are not an easy topic for many new homebuyers. The basic explanation of paying discount points is that you are paying some of your interest to the bank in the beginning in order to lower your mortgage payments later on, during the course of the mortgage. Obviously, a lower rate will mean a lower monthly mortgage.
When lenders speak of a point, they mean 1% of the total loan. For example, for a $200,000 loan, each point would cost $2,000. You can buy more than one point and lower your loan rate even more.
As anyone who has been shopping for a loan knows, the credit score determines the loan rate, and then the point reduction is taken off this rate. If you are quoted 6% on your $200,000 mortgage, you may receive a different quote for your loan if you were paying points. Each bank has its own way of figuring this, but they fall within the same scope, and the norm is that 1 point lowers a fixed rate mortgage by .25% and an adjustable rate mortgage by .375%. If we use the $200,000 loan in the above paragraph, 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 loan rate, you will most likely see the rate quoted along with points. So, if you see a 6% rate, next to it will be the quotes for 1 point, 2 points, etc. Next you would see 7%, with the accompanying rate reductions per point, and so on for each rate. This is why it is necessary to know your original rate and then calculate downward for points.
It is clear that a monthly loan 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 worthwhile investment, but you have to keep in mind that you are basically paying interest up front. If you only held onto the loan for a short while, after you sell the house or negotiate a new mortgage, you will have paid this interest for a loan you don’t have. 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 will mean that he can afford to pay more for a house. A seller may advertise “seller pays points” to attract more buyers. But keep in mind that this may increase the price of the home by the amount of the points.
Borrowers do not have to pay points, they do it if they are interested in reducing the rate. It is a completely voluntary decision based on his analysis of the costs involved.
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