All about Points
When considering mortgages, you’ve likely heard people use the term “points”, but there’s a bit of confusion as to what these points are, and what they do. “Points” are paid to lower your interest rate, but in mortgage terms, a point is a fee based on 1 percent of the total mortgage amount, so one point of a $100,000 mortgage would be $1000.
There are 2 main types of points that you’ll come across, discount and origination…
First, let’s look at discount points. Borrowers can offer to pay a lender discount points in order to reduce the interest rate on their loan. This way, they obtain a lower monthly payment in exchange for an up-front fee.
For each point purchased, the loan rate can be reduced from 1/8th to a quarter of a percent, although the lender will probably put a limit on the number of points you can buy.
Now this may seem like a great idea, but is it really such a bargain? Well, it depends on how long you plan to stay in the home. The longer you stay, the more valuable those pre-purchased points are. There will be a specific point in the timeline of the loan where the money spent to buy down the interest rate will be equal to the money saved by making reduced loan payments. Selling the property or refinancing prior to this break-even point will result in a net financial loss, while keeping the loan for longer than this break-even point will result in a net financial savings.
The longer you keep the property financed under the loan with purchased points, the more the money spent on the points, will pay off.
If you do end up splashing out on a couple of points, the good news is, they may be tax deductible for the year they are paid, but there are quite a few requirements to fulfill, including itemizing your deductions. If it’s a refinance mortgage, then you can deduct points over the loan period.
The other type of points you might run into are origination points. Typically, origination points are used to pay for the costs of obtaining the loan in the first place, it’s the loan officers’ compensation, if you will.
It is up to the individual lender whether or not they charge origination points and, unfortunately, they don’t provide the borrower with any valuable benefits and are not tax deductible, so you’re therefore probably better off trying to get a loan that doesn’t require you to purchase these kinds of points. Although all points are an up front fee paid to the lender at closing, there are different ways to look at points and their meaning, so make sure you look at the bottom line and not the number of points.
Before making a final decision, look over all details of the offer so you know what you’re paying for, and what you’re getting in return.
Knowing what points are and what they’re for, can save you money and hassle, and knowing is half the battle.
Written for National Association of Realtors®
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