Canada Life Insurance Quote: What Are Mortgage Points All About?
There are many borrowers who get confused when they are quoted home loan rates with points. The basic explanation of paying discount points is that you are paying some of your interest to the bank upfront in order to lower your mortgage payments later on, during the course of the mortgage. When the rate is less, so will the monthly loan payment.
When lenders talk about a point, they mean 1% of the total loan. If you are obtaining a $200,000 mortgage, one point would cost you $2,000 at closing. The more points you are willing and able to pay, the lower the rate on your loan will be.
As anyone who has been shopping for a loan knows, one’s credit rating determines the loan rate, and then the point reduction is taken off this rate. A buyer who may have been quoted 6% based on his credit rating, will receive a series of different quotes based on points. Each bank has its own formula, but they fall within the same limits, and the norm is that 1 point lowers a fixed rate mortgage by .25% and an adjustable rate mortgage by .375%. In the case of your $200,000 home loan that you are willing to pay $2,000 for one point, your loan would then be reduced to 5.75% for a fixed rate loan and 5.625% for an adjustable rate mortgage.
If you inquire about a mortgage rate, you will most likely see the rate quoted along with points. In other words, the quote may be 6%, 5.75% (1 point), 5.5% (2 points), etc. Next you may see 7%, with the accompanying rate reductions per point, and so on for each rate. This is what makes it important that a borrower know what the point system represents.
Obviously, your mortgage payment is going to be lower on a loan with 5.75% or 5.625% than it will be on a loan with a 6% rate. Lowering the rate like this is because you are really paying some of your interest beforehand. If you only held onto the mortgage for a short while, after you sell the house or negotiate a new mortgage, you will have paid this interest for a loan you don’t have. You have to spread the cost of the points over the time you plan to live in the home.
Since a home buyer is going to have a lower loan payment, this will mean that he can afford to pay more for a home. For this reason, sellers frequently offer to pay points as a sales pitch. But this shouldn’t change the initial calculations, because the price of the home will reflect the seller’s contribution.
There is no obligation on the part of the buyer to pay points. It is a completely voluntary decision based on his analysis of the costs he will have.