What are “Points?”

“Do I have to pay the buyer’s points?” is a common question asked by sellers. “Just what are ‘points,’ anyway?” is another question asked, especially by those have not had experience with real estate transactions. Most of the time, they already know that one point equals one percent of the loan amount.

Sometimes, “points” is a term loosely used to encompass all of the buyer closing costs, i.e origination fees, credit report, underwriting, etc. So why should a seller pay closing costs for the buyer? The answer is quite simple; to get the house sold. Most of today’s buyers have good income but little cash reserves. Now that most zero-down programs are disappearing, buyers have a harder time coming up with cash to close. They may barely have enough for a down payment. However, in most cases, the lender will allow the seller to contribute up to 3% of the sale price toward closing costs, discount points, and pre-paids. Three percent might seem to be a lot of money for the seller to produce. Keep in mind that sometimes some or all of that amount can be added to the price of the home, so the buyer is actually financing part or all of that contribution. The important thing to remember with this sort of offer is to examine the bottom line, instead of focusing on the contribution requested by the buyer.

Discount Points

When REALTORS and lenders are talking about “points,” they are usually talking about discount points.

Here is the explanation on discount points for you:

Discount points are basically monies that are paid up-front (at closing) to permanently buy down the interest rate on the buyer’s mortgage. As a rule of thumb, one discount point (1% of the loan amount) will buy down the rate by .25%. This is charged to the seller, but a contribution from the seller could also cover this cost.

The most important thing to consider when looking at paying points is how long will it take to recoup the up front cost (points) vs how saving on monthly payment is realized by buying down the rate. Below is an example:

A 350K loan at a zero point rate of 6.00% the P&I payment is: $2,098.42

The same loan amount paying one discount point ($3,500.00) up front and getting a rate of 5.75% the P&I is $2,042.50

In the above scenario it would take 63 months to recoup the $3,500.00 paid to buy down the rate. This does not even take into account the potential growth of the $3,500.00 if had been placed in an investment and earning a rate of return.

With this example it would make sense to pay the discount point if you were going to be in the house over 63 months. Considering the time-value of money, it would make more financial sense to stay in the home longer. Of course, the longer you stay in the home, the more sense it makes to pay discount points.

Ask your loan officer to help you make some calculations to determine how long it will take you to recover the cost of discount points.

Possibly related posts:

1. How to Select a Loan Officer
2. What is “Arbitration?”