What is the purpose of points in a real estate loan?

Points in a real estate loan serve a specific purpose related to lender compensation. When a borrower pays points, they are essentially paying a fee upfront to the lender in exchange for a lower interest rate on the loan. This upfront payment allows the lender to receive a portion of their earnings upfront, which can offset the cost of lending over the term of the mortgage.

Points are typically expressed as a percentage of the loan amount, where one point equals one percent. By purchasing points, borrowers can often secure a better interest rate, which can lead to significant savings over the life of the loan. This mechanism is beneficial for both the lender, who receives compensation immediately, and the borrower, who can reduce their monthly payments through the lowered interest rate.

Understanding the function of points helps borrowers make informed decisions regarding their financing options and consider the long-term implications of their financial choices.