California Real Estate Broker ExaminationFinancingEasy
A borrower is seeking to purchase a new home and is comparing loan options. One lender offers a loan with an interest rate of 4.5% and 2 discount points. Another lender offers a loan with an interest rate of 4.75% and no discount points. Assuming each discount point costs 1% of the loan amount, which statement is true regarding the initial cost of the loan with discount points?
- ADiscount points are a form of prepaid interest that is tax-deductible in all cases.
- BDiscount points reduce the overall loan amount repaid.
- CDiscount points increase the monthly principal and interest payment.
- DDiscount points are an upfront fee paid to the lender to reduce the interest rate.
Show answer & explanationAnswer & explanation
Correct answer: D. Discount points are an upfront fee paid to the lender to reduce the interest rate.
Discount points are a common financing tool where borrowers pay an upfront fee to the lender in exchange for a lower interest rate over the life of the loan. This reduces the monthly interest payment.
Why the other options are wrong
- A. While often tax-deductible, it's not 'in all cases' and is primarily a fee to reduce the rate, not just prepaid interest.
- B. Discount points reduce the interest rate, not the overall loan amount repaid, though they can reduce total interest paid over time.
- C. Discount points reduce the interest rate, which in turn reduces the monthly principal and interest payment, not increases it.
Discount Points
An upfront fee paid to the lender at closing to reduce the interest rate on a mortgage.
- Each point typically costs 1% of the loan amount.
- Paid by the borrower to 'buy down' the interest rate.
- Reduces monthly payments over the life of the loan.
Memory trick: Points Pay Less Interest