What Are Discount Points?

Whether buying or selling a home, the word "discount points" can strike fear
in the heart of your checkbook. Why? They are a fee charged to either the
buyer, the seller, or both, by mortgage lenders.

In the 1940s, when "points" were originally created, they served a narrow
and specific purpose. When the Federal Housing Administration first began
offering "FHA" loans, interest rates were set lower than rates offered on
"conventional" loans. To compensate for the lower rates, lenders created a
system in which one discount point was equal to 1/8% interest on a mortgage,
or one percent of the loan amount.

For example, if interest on FHA loans was 5 3/4%, when 6% could be charged
on a conventional loan, the lender would be short two-eighths of one percent
interest on that loan. To compensate for the difference, an up-front fee of
two discount points (equal to 2/8 of 1%) was charged to make up the
difference.

Today, discount points are charged on almost all mortgage loans, including
FHA, VA and Conventional. The purpose of charging points today is to
increase the lenders "yield" on the mortgage.

Each point still equals 1% of the mortgage amount. Because a point increases
the lenders' yield in small increments, 1/8%, it is used to compensate for
daily fluctuations in the money market, without the need for daily interest
rate changes. Without points, interest rates would be on a constant
roller-coaster ride attempting to find a market level acceptable to lenders.

Because points are used by lenders to adjust for daily fluctuations in money
markets, quotations should be obtained when buying or selling a home. Points
can then be "locked-in" for a period of time when obtaining a loan.

Who pays the discount points? Payment is often negotiable between buyers and
sellers, but must be paid by the sellers on some loans. Your real estate
agent can explain points in more detail.