Points
One of the terms you hear frequently when you are shopping for
a loan is “points.” Often an interest rate is quoted
followed by a certain number of “points.” As an example,
a lender may say that he or she has a “seven percent loan
with two points.” But what exactly are “points”
and how much of a role do they play in your search for a second
mortgage home loan?
From a strictly monetary standpoint, a “point” is
one percent of the value of the loan you are seeking. For example,
if you are looking to get a $100,000 loan then one “point”
equals $1,000 (1 percent of $100,000 equals $1,000). But that
doesn’t really answer the question of what a “point”
is, or why lenders quote the number of “points” when
they quote the cost of a loan.
What exactly is a “point”? In a nutshell, it is a
method of prepaying for interest. At the close of escrow you are
expected to pay the “points” on your loan in the form
of cash. Occasionally a lender may add the points into your loan
amount. While this may seem like a good idea, what the lender
is actually doing to getting you to pay interest for several years
on the interest payment you have supposedly already made.
How can you use “points” to your advantage? You and
your lender can play around with the “points” to affect
the interest rate that you will pay on your loan. If you are willing
to pay additional “points” up-front, that is, pre-pay
more of your interest, the lender will lower the interest rate
that you will pay for your loan. By lowering your interest rate,
it lowers the payment that you will make on your loan for the
entire duration of your loan.
If you are short on up-front cash it may be possible to negotiate
with your lender to pay fewer “points” up-front that
the lender is asking for in exchange for a higher rate of interest,
as well as, a higher monthly payment) on your loan.
This can still work to your advantage if interest rates drop
after you make the deal to pay fewer “points” and
you are able to refinance the entire loan at a lower rate.
“Points” are often used so that lenders can advertise
what appears to be a very low interest rate in order to attract
more customers. Don’t be fooled. When you look at a quoted
interest rate, your first question should always be “How
many points?” Any comparison of interest rates must also
include a comparison of “points.”
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