There are many home buyers who are confused when they are quoted mortgage rates with points. Points are upfront fees given to the lender to induce them to lower the interest rate on a loan. Obviously, a reduced rate will mean a lower monthly payment.
When lenders speak of a point, they mean 1% of the total loan. For example, for a $200,000 mortgage, each point would be $2,000. A borrower has the option of paying one or more points on the loan.
As anyone who has been shopping for a loan knows, one's credit score determines the loan rate, and then the point reduction is taken off this rate. A buyer who may have been quoted 6% based on his credit score, will receive a series of different quotes based on points. A general rule, but one that changes from bank to bank, is that one point will lower the loan rate .25% on a fixed rate loan and .375% on an adjustable rate loan. In the case of your $200,000 mortgage that you are willing to pay $2,000 for one point, your loan would then be reduced to 5.75% for a fixed rate loan and 5.625% for an adjustable rate mortgage.
If you inquire about a mortgage rate, you will most likely see the rate quoted with the points. So, if you see 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. So it is important to understand what the rate you will pay without points is in order to find the rate you will have with 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. This sounds like it would always be a good 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 plan on living in the home. You have to spread the cost of these points over the time you plan on living in the home.
Many times home sellers use points to encourage buyers. This is why you will see homes advertised with a notice that the seller is willing to pay points. But keep in mind that this may raise the price of the house by the amount of the points.
It is important to note that there is positively no obligation on behalf of the borrower to pay points. It's a decision that a borrower can examine depending on many of the other factors in the mortgage.
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