Whether buying or selling a home, the word "discount points" can strike fear in the heart of your checkbook. Why? They are a fee charged to either the buyer, the seller, or both, by mortgage lenders.

In the 1940s, when "points" were originally created, they served a narrow and specific purpose. When the Federal Housing Administration first began offering "FHA" loans, interest rates were set lower than rates offered on "conventional" loans. To compensate for the lower rates, lenders created a system in which one discount point was equal to 1/8% interest on a mortgage, or one percent of the loan amount.

For example, if interest on FHA loans was 5 3/4%, when 6% could be charged on a conventional loan, the lender would be short two-eighths of one percent interest on that loan. To compensate for the difference, an up-front fee of two discount points (equal to 2/8 of 1%) was charged to make up the difference. Today, discount points are charged on almost all mortgage loans, including FHA, VA and Conventional. The purpose of charging points today is to increase the lenders "yield" on the mortgage.

Each point still equals 1% of the mortgage amount. Because a point increases the lenders' yield in small increments, 1/8%, it is used to compensate for daily fluctuations in the money market, without the need for daily interest rate changes. Without points, interest rates would be on a constant roller-coaster ride attempting to find a market level acceptable to lenders.

Because points are used by lenders to adjust for daily fluctuations in money markets, quotations should be obtained when buying or selling a home. Points can then be "locked-in" for a period of time when obtaining a loan.

Who pays the discount points? Payment is often negotiable between buyers and sellers, but must be paid by the sellers on some loans. Your real estate agent, can explain points in more detail.