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Understanding Points and Buydowns

An important part of determining interest rates and putting together real estate mortgage deals involves loan points and interest buydowns. In fact, no understanding of mortgage interest is complete without knowing how these points and buydowns work—and most important, how you can use them to your advantage.

Essentially, points are prepaid interest on the loan. Each point is equal to a one-time fee of 1 percent of the loan amount. For example, if a lender charges you one point on a $200,000 loan, your cost is a flat $2,000. Typical examples of how points are used include the following:

  • If interest rates are fluctuating and lenders need to increase their yield (profit) to make a loan, they will charge points. For instance, a lender may quote you a 6 percent interest rate if you’ll pay two points or a higher 6.36 percent with no points.
  • When a lender wants to sound more competitive and advertises one-quarter or one-half percent interest rate below what the other lenders are offering, the fine print explains that to get that rate you will have to pay a point or two.
  • New home builders often advertise lower interest rates to get buyers interested in their projects, so they pay the lender the designated points to give you the lower rate. Of course, ultimately you pay for these points because they are built into the cost of the home.

Home sellers can offer to pay a few points on behalf of the buyer so as to entice interested parties to buy their home.

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