Mortgage Loans: What Are Points?
Points are prepaid interest on the mortgage loan. Often referred to as "discount points", each point is equal to one percent of the amount of the mortgage loan. For example, if a loan is for $25,000, one point is equal to $250. If a mortgage loan is 100,000, one point is equal to $1,000.
What is the purpose of points? They are charged by a lender to raise the yield on his loan at a time when money is tight, interest rates are high, or there is a legal limit on the interest rate that can be charged on a mortgage. Points reduce the interest rate on the mortgage loan by requiring prepayment of a small percentage of the total interest due. The number of points owed is up to your lender. For instance, a one point loan will always have a lower interest rate than a no point loan. Each point equals 1% of the total loan amount.
Note that with conventional loans, points can be paid by either the borrower or the seller or each can agree to pay half; however, borrowers are prohibited from paying points on HUD or Veterans' Administration guaranteed loans. (The seller would be required to pay.)
Should I pay points?
A rule of thumb regarding points is that the longer you plan to keep the house, the more points you can afford to pay. By keeping the house for at least four years, you will recoup the costs of the points by paying lower monthly payments. Here are some more general tips regarding points:
--If you plan to refinance or sell the house in the next four years, a no point loan would be the best plan.
--If you plan to stay in your home for a long time, pay more points in order to lower the interest rate as much as you can. Paying points now will save you lots of money in the long term.
Note that points are tax deductible if you pay for them up front and if you do not already own a home. You can deduct the entire cost of points in the year of closing. If you are buying a second home, you must spread out the deduction over the term of the mortgage.