A buyer is unfamiliar with the concept of discount points and asks a licensee to explain. The licensee responds, "Discount points are used to replace funds that are being held by the Federal Reserve, so that more funds are available to lend." Is this description correct?

• A. Yes, because discount points replace Fed funds
• B. No, discount points are used to increase the yield for lenders who will sell the loans on the secondary market
• C. No, they are prepaid taxes
• D. Yes, they decrease borrower rate

Answer: (B)

Discount points are prepaid interest paid at closing to obtain a lower loan interest rate. The licensee’s description wrongly ties points to replacing funds held by the Federal Reserve. They don’t replace Fed funds; instead, paying points gives the lender upfront cash, which increases the loan’s yield, especially for loans that will be sold in the secondary market to investors seeking higher returns. So discount points are best understood as a tool to boost the lender’s yield on the loan, with the borrower usually getting a lower ongoing rate as a trade-off.