There are many home buyers who get confused when they are quoted mortgage rates with points. Points are upfront fees paid to the lender that induces them to lower the interest rate on a loan. When the rate is lowered, so will the monthly loan payment.
One point equals 1% of the loan, and it is remitted to the bank at the loan closing. If you are obtaining a $200,000 loan, one point would cost you $2,000 at closing. You can buy more than one point and reduce your loan rate proportionately.
Your mortgage loan rate is determined 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%, based on your credit score, ask how much it would be if you are willing to pay any 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%. In discussing our example of a $200,000 loan, above, let’s say we want one point, that is, to get the loan rate reduced to 5.75% of 5.635%, depending on whether it is fixed or adjustable.
Most banks will quote mortgage interest rates with optional points along with them. So, if you see a 6% rate, next to it will be the quotes for 1 point, 2 points, etc. Next you may see 7%, with the appropriate 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.
It is clear that a monthly mortgage payment will be lower with a loan of 5.75% than with a loan of 6%, but you have to consider the points. What the borrower is effectively doing is paying a part of the interest ahead of time. This is why it is important to look at 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 loan payment, this usually means that he can afford to pay more for a home. For this reason, sellers frequently offer to give points as a sales pitch. But this shouldn’t change the original calculations, because the price of the house will reflect the seller’s contribution.
There is no obligation on the part of the buyer to pay points. It is a completely voluntary decision based on the borrower’s analysis of the costs he will have.
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