When you close on a home, you will be faced with a settlement statement. If you are taking out a mortgage to finance your home, that statement will include a mortgage settlement statement from your lender detailing the costs and fees associated with your loan. On that settlement, you'll notice something called "points." Just what are these "points?"
Lenders charge points to cover the costs of a loan. If a borrower has credit problems and is considered a risk, he or she may be charged more points than a borrower who has a better credit rating. Borrowers can also purchase points to lower the interest rate on their mortgage. These points represent additional money that a home buyer may have to pay to his lender at closing.
There are two different kinds of points: "Origination" points and "discount points."
"Origination" points are fees charged to you by your lender. These points cover some of the lender's costs for preparing and submitting the loan; it's also a way for the lender to earn more money from the loan upfront.
Each point charged is 1% of the loan's total amount. So, for one point on a $100,000 loan, you pay $1,000; for two points, you pay an extra $2,000, and so on. These points may be tax deductible if they meet certain conditions. (For more on mortgage points, read "Topic 504 -- Home Mortgage Points" from the Internal Revenue Service.)
"Discount" points are points that a borrower can choose to purchase (they are optional) to "buy down" the interest rate on a mortgage. While you'll have to pay more money upfront, these points save you more money over the length of the loan the longer you stay in your home.
These points are also expressed as a percentage of the total loan amount -- 1%. Therefore, a point on a $200,000 mortgage is a $2,000 fee, two points amounts to a charge of $4,000, etc.
For each point that you pay for, your lender will agree to lower the interest rate on your loan by a certain amount, usually somewhere between an eighth (.125) to a quarter (.25) of 1%. For instance, your lender may lower your interest rate from 6% to 5.75% for the cost of one point on your loan. If you purchase two points, you can have your interest rate lowered even more.
While discount points can save you money in the long run, they can add to your closing costs, and might not be worth it if you'll only own your home for a short period of time, or less than five years -- you might not save enough money in interest to cover the cost of your points.
A plus to discount mortgage points are that they also may be tax deductible. Read "Topic 504 -- Home Mortgage Points" from the Internal Revenue Service for more information.
When shopping for a home, you're going to be asked at some point whether you've been "pre-approved" or whether you have mortgage "pre-approval." You're going to want to answer "yes" to these questions -- buyers who can are in a much better position to purchase ...