During the real estate boom a few years ago, there was a lot of talk about points in regards to mortgages. This terminology confused some buyers, and the ambiguity took on negative connotations. The points system is simply a financial instrument sometimes used in the mortgage industry to structure mortgage loans, allowing flexibility for both the lender and the buyer.
What the Points System Means
Essentially, points are the same as percentages of the loan, in other words, 1 point is equal to 1 percent of the value of the loan.
There are two types of mortgage points. The first type is usually referred to as the discount points whereby a mortgagor through paying 1% of the loan up front, the mortgage rate is reduced by a certain percentage, often 0.125%. The advantage to this is that the mortgage lender receives some of his yield up front and the mortgage payer in turn secures a lower monthly payment for the duration of the loan. This type is tax deductible.
The second classification of mortgage points on a loan is called origination points. This type is less popular as it is essentially a fee to obtain a loan at a certain rate. It simply charges the mortgagor a fee to obtain a mortgage with a guaranteed interest rate. This brand of points system cannot be used as a tax deduction.
Things to Look For
When a prospective home buyer is searching for a home loan, and a loan is available for discount points, the buyer should decide how long he or she will live in the house before paying the points is worth the price. This is because the point’s fee must be factored in when totaling the overall savings of the lesser amount of the monthly payments. There is a breakeven point where after subtracting the money saved on the monthly payment equals the amount paid for the points fee. If the home is refinanced or sold before the break-even point, the mortgage owner will show a loss.