Illinois Real Estate Practice Exam

What is the purpose of discount points:

1. To mitigate risk to the lender

2. To increase the borrower's interest rate

3. To lower the borrower's credit score

4. To finance closing costs

The correct answer is: To mitigate risk to the lender

The purpose of discount points is to provide a means for borrowers to prepay a portion of their mortgage interest in exchange for a lower interest rate on their loan. This effectively reduces the overall cost of borrowing over time. By purchasing discount points, borrowers are able to lower their monthly payments and overall interest costs, making their mortgage more affordable. This practice can be beneficial for both parties: lenders receive the upfront payment from the discount points, which reduces their risk exposure by ensuring a higher degree of return on the loan, while borrowers benefit from the lower interest rate throughout the life of the loan. The connection to risk mitigation for lenders is key, as having borrowers pay additional upfront costs can enhance the lender’s potential to recover more in interest over the loan's duration, thus managing their risk effectively. In contrast, the other choices do not accurately reflect the primary function of discount points. Increasing the borrower's interest rate is not the objective; rather, the aim is to reduce it. Discount points do not have a direct impact on a borrower's credit score and their purpose is not primarily to finance closing costs, even though they may sometimes be related to the overall closing expenses.