Maria Center

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.

Students often overthink math problems involving points. 

All we have to remember is that a point costs the loan borrower  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. How much does Ben pay for the points?


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.

 
Lenders Like It When We Pay Discount Points- Here's Why:

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. Instead of handing you the $110.00 I promised, I tell you I'll pay you back $11 a week for 10 weeks instead.

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 discount 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 that interest right down in front of them, all at once. 

This benefits the lender because they can put that money to work sooner rather than later, usually making a higher profit.

For the lender, a buyer paying discount points increases the lender's yield on the loan.

Yield is another word we need to know and understand. It could be critical in understanding not just for the math questions on the exam, but also the real estate 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  (profit).


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

We are told in the question that Ben pays 5 percent interest on the loan.

 

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 (yield)

 
About the Author Maria Center

I began my career in real estate in Ohio in 2003 and currently work as a PrepAgent real estate exam tutor/instructor. 
I am licensed in Ohio, Florida, Alabama, Virginia, and Kentucky. I work as a Real Estate Broker at 1st Class Real Estate Expert Realtors in Philpot, Kentucky; Managing Broker at Renwick Realty in Middletown, Ohio; Associate Broker at 1st Class Real Estate Premier Homes in Ashland, Virginia; and as a broker in both Florida and Alabama. I am a licensed real estate instructor in Florida and teach finance and appraisal in Ohio. I look forward to helping you prep for success!


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