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Prime Rate and Mortgage Points Explained

February 26th, 2018 7:30 AM by Jackie A. Graves

When shopping for a home loan, chances are you are very interested in the mortgage rate you’ll pay, and for good reason. It can significantly affect the amount of money you’ll pay every month for your mortgage payment. Here’s a look at two important terms you may have come across in your home loan search: Prime Rate and Mortgage Points.

Prime Rate

Prime rate is the short-term interest rate charged by a lender to customers who are the least likely to default on their loans. The most credit-worthy customers receive the best or lowest rate that the lender would offer any of its customers. Each lending institution sets its own prime rate. The rate is almost always the same among major banks. Adjustments to the rate are made by banks at the same time, but the rate does not adjust on any regular basis.

The prime rate is usually adjusted at the same time and in correlation to the adjustments of the Fed Funds Rate, a short-term rate objective or target rate of the Federal Reserve Board. The term prime rate may also refer to the national prime rate or the WSJ (Wall Street Journal) prime rate. This is an average posted by the newspaper based on polls of the top 10 banks in the United States.

This posted rate has become an index for many types of loans. Lenders use the index as their base rate, and then add a margin (profit) based primarily on the amount of risk associated with a loan. This index – often used for consumer loans, like auto loans, home improvement loans and credit cards – is a popular base rate used for home equity lines of credit.

Mortgage Points

There are several costs involved in mortgage loan transactions. One of the closing costs charged by the lender is called ‘mortgage points’ or just ‘points.’ One ‘point’ is the equivalent of 1 percent of the loan amount. For example, if you purchase a home and borrow $100,000, every point would cost $1,000. These points are charged by the lender to obtain the amount borrowed at a particular rate. Points can be negotiated between the buyer and seller and can be paid by either party.

Additionally, there are two kinds of mortgage points: origination fees and discount points.

  1. Origination Fees
    Origination fees are fees charged by a lender for the cost of originating the loan. In other words, this is the lender’s income for doing the loan. Origination fees may or may not be tax deductible — you should check with your tax adviser. You can also learn about tax deductions of homeownership here.
  2. Discount Points
    Discount points are also charged by the lender at closing, but these points actually “buy down” the interest rate that is charged on the mortgage loan. Discount points are considered prepaid interest and are tax deductible. The more discount points paid on the loan, the lower the interest rate. Lenders’ charges for points can range from 0 to as many as the borrower would like to pay to lower their rate (usually no more than 3 or 4).

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Posted by Jackie A. Graves on February 26th, 2018 7:30 AM

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