by Harry M. Rather
Unless you have been in the mortgage market for some time, you may not be sure about the concept of discount points. It is a simple enough concept: in order to lower the interest on your loan, you pay your bank some cash upfront as an incentive to lower the rate. When the rate is less, so will the monthly loan payment.
One point is a cost equivalent to 1% of the total amount of the loan. For a $200,000 mortgage, one point costs $2,000. The more points you are willing and able to pay, the lower the rate on your mortgage will be.
Your home loan rate is calculated primarily by your credit worthiness, but whatever the rate on the loan, paying points will make it lower. For example, if your 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 one lender to another, is that one point will lower the loan rate .25% on a fixed rate loan and .375% on an adjustable rate loan. In the case of your $200,000 home loan that you are willing to pay $2,000 for one point, your mortgage would then be reduced to 5.75% for a fixed rate loan and 5.625% for an adjustable rate mortgage.
If you inquire about a mortgage rate, you will most likely see the rate quoted with the points. For example, the bank 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. This is why it is necessary to know your original rate and then calculate the reduction for points.
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. Lowering the rate like this is because you are really paying some of your interest beforehand. If you only held onto the loan for a short while, after you sell the house or refinance, you will have paid this interest for a loan you no longer have. In other words, you have to amortize the payment amount for the points over how long you plan to have the loan.
Many times home sellers employ points to get buyers. A seller may advertise “seller pays points” to bring in more buyers. But this shouldn’t change the original calculations, because the price of the house will reflect the seller’s contribution.
Borrowers do not have to pay points, they do it if they are interested in reducing the rate. It’s a decision that a borrower can examine depending on all of the other factors in the loan.
