Also Called a Discount Point
are a Form of Pre-paid Interest
Points, sometimes also called a "discount point", are a form of pre-paid interest. One point equals one percent of the loan amount. By charging a borrower points, a
lender effectively increases the yield on the loan above the amount of the stated interest rate. Borrowers can offer to pay a lender points as a method to reduce the interest rate on the loan, thus obtaining a lower monthly payment in exchange for this up-front payment. For each point purchased, the loan rate is typically reduced by 1/8% (.125%).
Paying Points represent a calculated gamble on the part of the
buyer. There will be a specific point in the timeline of the loan where the monies spent to buy down the interest rate will be equal to the monies saved by making reduced loan payments resulting from the lower interest rate on the loan.
Selling the property or refinancing prior to this break-even point will result in a net financial loss for the buyer while keeping the loan for longer than this break-even point will result in a net financial savings for the buyer. The longer you keep the property financed under the loan with purchased points, the more the monies spent on the points will pay off. Accordingly, if the intention is to buy and sell the property or refinance in a rapid fashion, buying points is actually going to end up costing more than just paying the loan at the higher interest rate.
Points may also be purchased to reduce the monthly payment for the purpose of qualifying for a loan. Loan qualification based on monthly income versus the monthly loan payment may sometimes only be achievable by reducing the monthly payment through the purchasing of points to buy down the interest rate, thereby reducing the monthly loan payment.
Discount points may be different from origination fee or broker fee. Discount points are always used to buy down the interest rates, while origination fees sometimes are fees the lender charges for the loan or sometimes just another name for buying down the interest rate. Origination fee and discount points are both items listed under lender-charges on the HUD-1 Settlement Statement.
The difference in savings over the life of the loan can make paying points a benefit to the borrower. If you intend to stay in your home for an extended period of time, it may be worthwhile to pay additional points in order to obtain a lower interest rate. Any significant changes in fees should be re-disclosed in the final good faith estimate (GFE).
Also directly related to points is the concept of the 'no closing cost loan'. If points are paid to acquire a loan, it is impossible at the same time for a broker bank or lender to make a premium for a higher rate. When premium is earned by making the note rate higher, this premium is sometimes used to pay the closing costs.