What happens to the nominal interest rate if a borrower pays discount points upfront?

When a borrower pays discount points upfront, it effectively lowers the nominal interest rate on the mortgage. Discount points are fees paid to the lender at closing in exchange for a reduction in the interest rate over the life of the loan. Each point typically costs 1% of the loan amount and reduces the interest rate by a certain percentage, usually around 0.25% per point.

By paying these points upfront, the borrower is prepaying some of the interest in advance. This results in a lower monthly payment since the overall cost of borrowing is reduced. The rationale behind this is that lenders are willing to offer a lower interest rate in exchange for the upfront payment because it provides them with immediate income.

Other options like an increase in the interest rate, keeping it unchanged, or fluctuations based on the market do not accurately reflect the relationship between discount points and nominal interest rates. Discount points are primarily a tool to adjust the rate, and the strategic use of them is common in real estate transactions to optimize loan conditions for borrowers.