What is the purpose of points in a mortgage transaction?

Points in a mortgage transaction are essentially upfront fees that borrowers can pay to lower the interest rate on their mortgage. This process is known as "buying down" the rate. Each point typically equals one percent of the total loan amount and can lead to long-term savings on monthly payments because a lower interest rate means less money paid in interest over the life of the loan.

When points are paid, borrowers essentially prepay some of their interest in exchange for a lower ongoing interest rate, which can result in significant savings over time. This approach is often beneficial for those planning to stay in their home for an extended period, as the lower monthly payments can substantially offset the initial cost of the points paid at closing.

In contrast, the other options do not accurately represent the function of points. They do not directly increase monthly payments or pay for closing costs, and they are not a guarantee of loan approval. Understanding this function of points is crucial for borrowers making informed decisions about their mortgage options.