When obtaining a mortgage loan the buyer often has to pay discount points those points are a percentage of?

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What determines the amount of a discount point?
Who pays for discount points?
How are discount points paid?
How else can points be used?
What else can help me prepare to pass my real estate licensing exam on my first attempt?

Discount points are a fee charged by a lender on a loan. Discount points are used by the lender to increase the yield on a lower-than-market-interest loan and to make the loan more competitive with higher-interest loans. Although not discount points, points can be used to cover loan origination fees.

What determines the amount of a discount point?

Each discount point is equal to one percent of the loan amount. Confusion in this area is what usually trips people up on the real estate exam. A discount point is equal to one percent of the loan amount NOT the purchase price. Be careful of this on the test.

For example, if a buyer purchases a home for $500,000 and puts 20% down in cash while obtaining an 80% loan to finance the rest a

discount point would be equal to one percent of $400,000, NOT $500,000. $400,000 is the loan amount, which is 80% of the purchase price. In this case, a point would be equal to $4,000, which is 1% of $400,000.00.

Here is a sample discount point real estate license test question:

Gerry purchases a home for $350,000, and obtains a 4.5% loan for $315,000, with three discount points. How much did Gerry pay total for the discount points?

A. $10,500 B. $3,500 C. $3,150

D. $9,450

Answer: D

Explanation: You have to know two pieces of information to get this question correct. First, you have to know the cost of a point, which is one percent. Second, you have to know that it is one percent of the loan amount, not the sale price of the property.

Discount points are used by lenders to increase the yield on the loans they provide. For a borrower, it is a way to buy down the interest rate on the loan during the term of the loan. Additionally, the money paid for the discount points is generally tax deductible to the borrower.

Who pays for discount points?

Either the buyer or seller may pay discount points. Points paid for residential real estate can usually be used to reduce taxable income in the year in which they are paid, a benefit to the buyer, even if the seller pays the points.

How are discount points paid?

Borrowers often pay discount points upfront to gain a long-term, lower interest rate, an advantage fo the buyers who plan on keeping the loan for an extended period, and not so useful for loans held only a few years.

When points are paid to lower the interest rate, it’s called a buydown. The buydown can be applied to reduce the interest rate over the life of the loan or for a specific period, like the first year or two.

Borrowers who use their buydowns to lower the interest rate during the short term are usually anticipating larger incomes later on during their loan repayment schedules. As an example, builders of new homes may pay points to lower the interest rate for a few years to attract buyers to their development.

How else can points be used?

Although not discount points, points sometimes are used to calculate loan origination fees. A borrower may pay one or two points – 1 percent or 2 percent of the loan amount – to the lender for administrative charges associated with the loan. This payment, however, won’t’ reduce the interest rate on the loan. Origination fees sometimes are paid to mortgage brokers, who are individuals who don’t lend their own money but rather arrange loans between borrowers and lenders.

What else can help me prepare to pass my real estate licensing exam on my first attempt?

Other tips to help you pass your real estate licensing exam on your first attempt:

Real Estate Test Taking Tips

How to Pass the Real Estate Exam

Real Estate Exam Math Made Easy

Also, check out our question of the day videos on our YouTube channel:

PassMasters Real Estate Exam Prep YouTube Channel

Mortgage points are fees paid to the lender for a reduced interest rate
Terms around mortgage points vary from lender to lender
It’s important to consider how long you’ll own the home and the time it will take to recoup the cost of buying points

Mortgage points, also known as discount points, are fees a homebuyer pays directly to the lender (usually a bank) in exchange for a reduced interest rate. This is also called “buying down the rate.”

Essentially, you pay some interest up front in exchange for a lower interest rate over the life of your loan. Each point you buy costs 1 percent of your total loan amount.

Buying points to lower your monthly mortgage payments may make sense if you select a fixed-rate mortgage and plan on owning the home after reaching the break-even period. The break-even period is the time it takes to recoup the cost of buying points.

Depending on your circumstance, buying mortgage points can save you significant money over the course of your loan. Here’s an example:

$200,000 loan

	Costs per point(s)	Monthly payment**	Total savings on a 30-year loan
0 points (4.5% APR*)	$0	$1,013.37	N/A
1 point (4.25% APR*)	$2,000	$983.88	$10,616.40
2 points (4% APR*)	$4,000	$954.83	$21,074.40

*Sample APRs and points are for illustrative and educational purposes only and are not an actual rate quote, prequalification or commitment to lend. Actual rate buydown per point varies by loan program and market conditions.

**This is the cost of principal and interest only; taxes and insurance are not included in this example.

When you consider whether points are right for you, it helps to run the numbers. Determine whether you have the cash available to buy points up front, in addition to your down payment, closing costs and reserves. Also, consider how long you plan to own the home. Your lender can help you decide whether paying points is right for you. Here’s how to calculate your break-even point:

$4,000

Your up-front mortgage points cost

$58.54

Your monthly payment savings

Number of months to reach your break-even point

Payments beyond your break-even point are where you really start saving. For example, if it takes 68 months to hit your break-even point, you would have a little more than 24 years left on a 30-year mortgage.

The terms around buying points can vary greatly from lender to lender. Here are some important things to consider:

The lender and the marketplace determine your rate reduction, and it can change after the fixed-rate period for your mortgage ends. That’s why it’s important to make sure your break-even point occurs well before the fixed-rate expires. For Bank of America customers, however, if rates go up during the adjustable period, your rate will be lower based on the points you initially purchased.

Contact a tax professional to see whether buying mortgage points could affect your tax situation.

If you need to decide between making a 20 percent down payment and buying points, make sure you run the numbers. A lower down payment can mean also paying for private mortgage insurance (PMI), which could cancel out the benefit of buying points for a lower interest rate.

* Maximum income and loan amount limits apply. Fixed-rate mortgages (no cash out refinances), primary residences only. Certain property types are ineligible. Maximum loan-to-value (“LTV”) is 97%, and maximum combined LTV is 105%. For LTV >95%, any secondary financing must be from an approved Community Second Program. Homebuyer education may be required. Other restrictions apply.