What do points cost a borrower?

When a homebuyer purchases a point, aka discount point, they pay 1 percent of the loan amount per point.

People get confused about this all the time and they think that points are some mystery automatic number, like $1000 each.

Nope, they cost 1 percent of the loan amount. That's all, it's really that simple.


Example- Ben is purchasing a home for $220,000. He is receiving an 80 percent loan to value (LTV) loan from his lender, paying 3 points, and being charged a 5 % interest rate


Here are a couple of real estate exam test questions we might see based upon this example:

Step 1: How much is Ben borrowing? 

Ben is purchasing his home for $220,000. He is getting an 80 percent loan to value loan, meaning he is borrowing 80 percent of the value of the home. Therefore $220,00.00 (purchase price) x .80 (LTV)= $176,000 loan

 

Step 2: How much will Ben pay for the 3 points?

Since we now know how much Ben is borrowing from Step 1 (his loan amount is $176,000), we can calculate how much he will pay in points. Remember, each point costs the borrower 1 percent of the loan amount, and since Ben is buying 3 points, he will be paying 3 percent of his loan amount.

$176,000 (loan amount) x .03 (3 percent)= $5,280. 

Ben will pay $5,280 for those three points he's buying.

 

Why do lenders like us to pay points?

Let's say I borrow $100 from you, and tell you I'll pay you back $110.00 on Tuesday. Sounds pretty good, right?

Now suppose Tuesday rolls around and I call you. I tell you I'll pay you back $11 a week for 10 weeks instead of the lump $110 sum today. You're not thrilled. Even though I'm paying you back the same amount, it's taking you considerably longer to get your money, You could really use that money now!

When we buy points, we are basically pre-paying interest on the loan. The lender doesn't have to wait for interest payments to trickle in over the life of the loan. You are plopping a chunk of it right down in front of them all at once. They like that. They can use that money right now to make more money, which is good for them. 

It increases their yield on the loan. 

Yield is another word we need to know and understand, not just for the math questions on the exam, but also for the financing section.

When we increase the lender's yield on the loan we increase the amount of money they are making off the loan. Here's what you need to know about that:

For every point a borrower pays on their loan, their lender's yield on the loan increases by 1/8th of a percent.

When we pay points to our lender, we increase their yield.

When we increase the lender's yield, we increase the profit they make on the loan.


Example- Ben is purchasing a home for $220,000. He is receiving an 80 percent loan to value (LTV) loan from his lender, paying 3 points, and being charged a 5 % interest rate


Step 1: How much will the lender's yield increase when Ben pays 3 points?

Remember, for every point that I pay, the lender's yield increases by 1/8th of a percent. So in this case, because Ben is paying three points, the lenders yield will increase by 3/8ths of a percent.

Written ou: 1/8 +1/8+ 1/8th= 3/8

In case it's been a while since you've worked with fractions, we convert that to a decimal by dividing the top number of the fraction by the bottom number: 

3 divided by 8= .375

When Ben pays his three points, the lender's yield on the loan increases by .375 percent.

 

Step 3: How much will the lender's total yield be if Ben pays 3 points?

Since we know that Ben is paying 3 points, and we also know that Ben is paying 5 percent interest for his loan, we have what we need to solve this. 

5 percent (what Ben pays) + .375 (the added yield we calculated in Step 1)= 5.375 percent.

Ben's lender's yield on the loan will increase to 5.375 percent due to Ben's points paid.

Ben will pay 5 percent interest on his loan, but the lender will make 5.375 percent profit 

 

Step 2: How much will Ben pay in interest on the loan?

Don't overthink this one because they tell us the answer in the example. While reading the example we learn that Ben pays 5 percent interest on the loan.

 

If you need personalized, one-on-one real estate math help, please feel free to book an online session using the link in the top menu. Stay tuned for more math tips in upcoming posts!

About the Author

Maria Center

Maria Center began her real estate career in 2003 as a real estate agent in Ohio. She was licensed as an Ohio real estate broker in 2011, owned her own brokerage from 2011-2017, and currently works as an associate broker at Sibcy Cline Realtors.

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