When comparing different mortgages, many lenders will
give you quotes that include both loan rates and points.
What is a point?
A point is a fee that is charged at closing that is
equal to 1% of the loan amount. For example, a 30-year, $150,000
mortgage will have a rate of 7%, but come with 1 point, or a fee of
$1,500.
Lenders can charge as many points as they want to.
There are two different types of points: discount points and
origination points.
Discount points
Discount points are simply prepaid interest on a
mortgage. The more points you pay at closing, the lower the interest
rate on the loan. Borrowers are usually allowed to pay zero to four
points, depending on how low they need their rate to be. Discount
points paid at closing are tax deductible.
Origination points
Origination points are charged by the lender to cover
the cost of the loan or to make a profit. They are not tax
deductible and do nothing for you, the borrower. Most buyers should
avoid origination points, unless they are necessary to lower the
interest rate to a satisfactory level.
Should you pay points?
Whether or not you should pay points depends on a
variety of factors. You have to look at how much money you have
available to spend up-front, at closing, and how long you plan to
own the property.
When you pay discount points, you are reducing your
interest rate. If you plan on owning the home for a long time, the
reduced interest rate may be worth paying the points. You will have
less of a monthly payment with lower interest rates, giving you
extra money to invest elsewhere.
You have to look at your situation. If you need the
lowest possible closing costs, you can choose to pay no points for
your mortgage.
How points work
You are offered a 30-year fixed-rate mortgage for
$165,000 at 6% interest with no points. The monthly mortgage payment
of principal and interest is $989.
If you choose to pay two points at closing, $3,300
extra, you could reduce the interest rate to 5.5% and reduce the
monthly payment to $937. The savings difference is $57 each month.
Keep in mind that it would take you 64 months to make
up for the $3,300 spent in advance for the lower interest rate. If
you own the house longer than 64 months, you will save money by
paying points.
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