Unless you have been in the mortgage market for some time, you may not be sure about the concept of discount points. The basic explanation of paying discount points is that you are paying part of your interest to the bank in the beginning in order to lower your mortgage payments later on, during the course of the mortgage. When the rate is less, so will the monthly loan payment.
One point equals 1% of the loan, and it is paid to the bank at the loan closing. For example, for a $200,000 mortgage, each point would cost $2,000. A borrower has the choice of paying one or more points on the mortgage.
Your home loan rate is determined primarily by your credit worthiness, but whatever the rate on the loan, paying points will make it lower. If you are quoted 6% on your $200,000 mortgage, you may receive a different quote for your loan if you are paying points. There is no set amount, but most lenders will lower a fixed rate loan by .25% and an adjustable rate loan by .375% for each point paid. 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.
Most banks will quote mortgage interest rates with optional points alongside. So, if you are given a 6% rate, next to it will be the quotes for 1 point, 2 points, etc. On the next line, will be the quotes for 7%: 6.75% (1 point), 6.5% (2 points), etc. This is what makes it important that a borrower know what the point system represents.
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. 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. This is why it is important to examine points with a view to how long you think you'll be 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 mortgage payment, this will mean that he can afford to pay more for a home. 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 has to make sure the investment is worthwhile and that he is going to be in the house long enough to make it a difference.
Borrowers do not have to pay points, they do it if they are interested in lowering the rate. It is a completely voluntary decision based on the borrower's analysis of the costs he will have.
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