Canada Life Insurance Quote: Understanding Points
Unless you have been in the mortgage market for a while, you may not be sure about the concept of discount points. Points are upfront fees paid to the bank to induce them to lower the interest rate on a loan. When the rate is less, so will the monthly loan payment.
One point refers to a cost equivalent to 1% of the total amount of the loan. For example, for a $200,000 loan, each point would be $2,000. The more points you are willing and able to pay, the lower the rate on your mortgage will be.
Your home loan rate is determined primarily by your credit worthiness, but whatever the rate on the loan, paying points will make it lower. If you are quoted 6% on your $200,000 mortgage, you may receive a different quote for your loan if you were paying points. A general rule, but one that changes from one lender to another, is that one point will lower the mortgage rate .25% on a fixed rate loan and .375% on an adjustable rate loan. In discussing our example of a $200,000 loan, above, let’s say we want one point, that is, to have the loan rate reduced to 5.75% of 5.635%, depending on whether it is fixed or floating.
If you inquire about a mortgage rate, you will most likely see the rate quoted with the points. For example, the bank may list the rate as 6%, no points, 5.75%, one point, 5.5%, two points, etc. Then the table would show 7% with the pertinent reductions. So it is important to realize what the rate you will pay without points is to be able to find the rate you will have with points.
The monthly loan payment is lowered with each lowering of the rate; clearly a loan with a rate of 5.75% is going to be less than a loan with a 6% rate. What the borrower is effectively doing is paying some of the interest in advance. This means that if you do not have that mortgage for a long time, you will have prepaid this interest for nothing. In other words, you have to amortize the payment amount for the points over how long you think you will have the loan.
Since a home buyer is going to have a lower mortgage payment, this usually means that he can afford to pay more for a home. This is why you will see homes advertised with an offer that the seller is willing to pay points. But this shouldn’t change the initial calculations, because the price of the house will reflect the seller’s contribution.
There is no obligation on the part of the buyer to pay points. It’s a decision that a buyer can examine depending on all of the other factors in the mortgage.