What are discount points?
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?
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:
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