Most people have heard of points but not many understand why points are needed. Here’s a simple explanation:

One discount point is one percent of the loan amount. If the loan amount is $100,000, one point equals $1,000. Now imagine a mortgage banker phoning an investor and saying: “I took two loans today. One is for $100,000 at 7%; the other is for $100,000 at 7.5%. Which one would you like to buy?” The banker continues: “by the way, with the $100,000 loan at 7% interest, I also have a lump sum (points) of cash up front which will increase your yield to 7.5%.” Then, both loans would be equally desirable to the investor.

Since loans underwritten by the FHA and VA have fixed interest rates lower than conventional loans, they are not able to compete with conventional loans on the basis of interest rates alone. The number of points required at any given time depends on the spread between VA and FHA rates and conventional mortgages.