Points paid at closing are:
Audio Lesson
Duration: 2:37
Question & Answer
Review the question and all answer choices
The same as the down payment
A is incorrect because points are not the same as the down payment. The down payment is the buyer's equity contribution, while points are prepaid interest paid to the lender to buy down the interest rate.
Prepaid interest, with 1 point = 1% of loan amount
Applied to the principal balance
C is incorrect because points are not applied to the principal balance. They are prepaid interest that buys down the interest rate over the life of the loan, not a reduction of the loan amount itself.
Refundable if the loan is paid early
D is incorrect because points are not refundable if the loan is paid early. They represent prepaid interest for the full term of the loan and are considered a cost of obtaining that specific interest rate.
Why is this correct?
B is correct because points are specifically defined as prepaid interest that borrowers pay at closing to reduce their interest rate. One point always equals 1% of the loan amount, making this the precise definition tested in the question.
Deep Analysis
AI-powered in-depth explanation of this concept
Understanding points is crucial in real estate practice because they directly impact a buyer's purchasing power and long-term affordability. Points represent a significant portion of closing costs and can affect whether a transaction closes smoothly. The question tests your fundamental knowledge of what points actually are in financing. Option A confuses points with the down payment - two separate components. Option C incorrectly suggests points reduce principal, when they actually buy down the interest rate. Option D is incorrect because points are prepaid interest, not refundable. The correct answer B recognizes that points are prepaid interest, with each point equal to 1% of the loan amount. This question challenges students who may confuse different financing terms or misunderstand how points function in mortgage calculations. Points connect to broader concepts like closing costs, loan qualification, and buyer affordability counseling.
Knowledge Background
Essential context and foundational knowledge
Points are a fundamental concept in mortgage financing that allows borrowers to 'buy down' their interest rate by paying an upfront fee. This practice exists because lenders offer different rate structures based on risk and profit calculations. Points represent the lender's yield on the loan - more points mean a lower interest rate because the lender receives more upfront compensation. This concept is particularly relevant in times of fluctuating interest rates, as buyers may consider paying points to secure a lower fixed rate when rates are rising, or avoid points when rates are expected to fall.
Think of points like buying in bulk - paying more upfront (points) gets you a lower 'unit price' (interest rate) over time.
When you see 'points' on the exam, visualize the bulk purchase analogy to remember it's prepaid interest that lowers your rate.
Remember 'PI = Points are Interest' to distinguish points from principal or down payment. One point always equals 1% of the loan amount.
Real World Application
How this concept applies in actual real estate practice
A buyer is purchasing a $400,000 home and qualifies for a 30-year fixed loan at 4.5% with no points, or 4.25% with one point. The loan officer explains that one point equals 1% of the loan amount ($4,000), which would be paid at closing. The buyer must decide whether the $4,000 upfront cost will save enough in monthly payments to justify the expense. An agent must help the buyer understand this trade-off and calculate how many months of savings would be needed to recoup the points investment.
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