How Do Mortgage Points Work?

By Realty Times Published Mar 7, 2022 02:45 pm

When you close on a loan, there’s a term you may hear—mortgage points.

Mortgage points are part of your closing costs. There are origination points, which are one type of mortgage point. There are also discount points. The two are different from one another despite being categorized together.

In instances of both origination and discount points, each point is usually equal to 1% of the total amount you’re mortgaging. So, if you get a home loan for $350,000, one mortgage point is equal to $3,000. Both points are listed in your official loan estimate and closing disclosure which you get from your lender.

Below, we talk more about the two specific types of mortgage points and how each works.

What Are Origination Points?
Origination points are paid by borrowers as a way to compensate a lender.

Not all lenders of mortgages require paying origination points. For those lenders who do require origination points to be paid on a loan, they are negotiable.

Origination points aren’t tax-deductible, and many lenders have moved away from them altogether in favor of no-fee or flat-rate home loans.

What Are Discount Points?
Discount points are considered interest that you’re pre-paying. When you buy a point, it lowers the interest rate on your mortgage by up to 0.25%. Many lenders offer the opportunity to buy a fraction of a point up to three discount points.

Before the Tax Cuts and Jobs Act was passed in 2017, applying to tax years 2018 through 2025, origination points weren’t tax-deductible. Discounts points could be deducted on Schedule A previously.

Now, discount points can be deducted, but they’re limited to the first $750,000 of your loan. There is a higher standard deduction as well, so you should consult with an accountant to figure out the specifics of the tax benefits for purchasing points.

When you’re deciding if you want to pay for discount points, first think about how long you plan to live in the house. Then, you’ll have to think about if you have enough money to pay for the points out-of-pocket.

As far as the first factor of how long you’ll live in the house, the longer you plan to stay, the more savings you’re likely to get if you purchase discount points. If you’re only going to stay a few years, you might skip buying discount points altogether.

As far as the money to pay for the discount points, you may not have enough to use this option if you’re already feeling the pinch of your down payment. If you were buying a $500,000 home, for example, to buy three discount points would cost you $15,000.

You might simply be priced out of the option.

You could also invest your money in other ways and get a better return than you would for the amount you would save if you paid for the points.

If your priority is paying off your mortgage, you might not worry as much about alternative returns.

There’s no one right answer for everyone as far as buying discount points. You need to crunch the numbers in your situation, and you might find you’re better off making a large down payment or buying a less expensive home.

You also need to comparison shop when you get a mortgage. There are a lot of options to choose from, and you can usually negotiate or avoid origination points altogether if you comparison shop.

As far as discount points, yes, you can save over the life of your loan, but only if you’re able to maintain a 20% down payment. Otherwise, with less than a 20% down payment, you may have to pay private mortgage insurance (PMI).