Final answer:
The upfront charge to lower the mortgage interest rate is called discount points, a form of prepaid interest. By paying points, borrowers can receive a lower interest rate over the duration of their loan, leading to potential long-term savings.
Step-by-step explanation:
The upfront charge that Gerard is considering paying to reduce his interest rate from 4% to 3.75% on his $300,000 mortgage is called a point or, more specifically, discount points. These points are a form of prepaid interest that a borrower can choose to pay as a way to lower the interest rate on their loan. Typically, one point costs 1% of the loan amount and lowers the interest rate by a certain amount, which varies depending on the lender and current market conditions.
For example, if homeowners cannot keep up with payments and default on their mortgages, this can lead to dire consequences. An adjustable-rate mortgage (ARM) may have an initial low rate, but that rate can escalate quickly, causing the monthly payment to become unaffordable. Such unpredictability is why some borrowers choose stable fixed rates, even if they come at a higher cost initially.
Understanding the total cost of a loan is crucial. Over time, even a relatively small change in the interest rate, like the drop from 4% to 3.75%, can result in significant savings on the total amount paid over the life of the loan. This is why some borrowers find value in paying discount points upfront.