There are many home buyers who get confused when they are quoted home loan rates with 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 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 closing of the mortgage. If you are obtaining a $200,000 loan, one point would cost you $2,000 at closing. A borrower has the choice of paying one or more points on the loan.
Your mortgage loan rate is calculated 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 another quote for your loan if you were paying points. Each bank has its own way of figuring this, but they fall within the same limits, and the norm is that 1 point lowers a fixed rate mortgage by .25% and an adjustable rate mortgage by .375%. If we use the $200,000 loan in the above paragraph, and we pay one point, we can reduce the rate to 5.75% on a fixed rate and 5.625% on an adjustable rate loan.
If you inquire about a loan rate, you will most likely see the rate quoted along with points. For example, the lender may list the rate as 6%, no points, 5.75%, one point, 5.5%, two points, etc. Then the table would show 7% with the relevant reductions. This is why it is necessary to know your original rate and then calculate the reduction for points.
Obviously, your mortgage 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 good investment, but you must keep in mind that you are really paying interest up front. If you only held onto the mortgage for a short while, after you sell the house or negotiate a new mortgage, 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.
Since a home buyer is going to have a lower mortgage 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 keep in mind that this may raise the price of the house by the amount of the points.
There is no obligation on the part of the buyer to pay points. It is merely his decision to reduce the interest rate of the loan.
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