They are generally used to buy down the interest rate on a home loan and decrease the amount of the monthly mortgage payment. In essence, a borrower buys a portion of their interest rate up front instead of paying it in monthly increments. Discount points are calculated as a percentage of the total loan amount.
A discount point is equivalent to 1 percent of the mortgage loan’s principal. Therefore, if a borrower buys four points on a $200,000 mortgage, they would pay $8,000 upfront. This $8,000 would be credited to the loan total, thus reducing the total loan amount. A borrower can generally purchase anywhere from one to four points, depending on the lender and the loan program.
The advantages of buying points are clear; the borrower pays less interest over the course of the loan. The more points the borrower pays, the lower the interest rate. For instance, if a borrower buys two points at the closing table, they could potentially save thousands of dollars in interest payments over the life of the loan.
The potential drawback to this option is that the rate may only be fixed for the initial period of the loan. Depending on a variety of factors, the rate might adjust after this initial period and become more expensive.
Interest rates are based on market conditions but ultimately determined by the lender. It is important to understand that lenders have some flexibility when it comes to setting the interest rate. Lenders can offer a better rate to a borrower who purchases points than someone who does not. Thus, if a borrower is interested in better rates, they may consider purchasing points at closing.
Summary and Analysis:
Discount points are a form of loan origination fees which are used to buy down the interest rate on a home loan and decrease the monthly mortgage payment. These points are calculated as a percentage of the total loan amount, with each point representing one percent of the mortgage loan’s principal. A borrower can typically purchase between one to four points, depending on the lender and loan program.
The advantages of buying points are that the borrower will end up paying less in interest over the life of the loan than if they had not purchased points. However, the downside is that the rate may only be fixed for an initial period, after which it can adjust to become more expensive.
Ultimately, interest rates are determined by the lender, who has the ability to offer a better rate to someone who chooses to purchase points at closing. Thus, borrowers who desire better rates may be wise to consider this option when obtaining a loan.
This article was contributed on Oct 17, 2023
