How to Calculate Points on a Loan

How to Calculate Points on a Loan
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Points on loans are most often found on secured loans--specifically mortgages. Points are percentages of a total loan amount. Points are either added to a principal loan amount or paid out of pocket by a borrower. There are two different types of mortgage points: origination points and discount points. Origination points are often called "the cost of doing business," while discount points can be paid to reduce a mortgage interest rate. Calculating these points is easy.

Decide whether to pay discount points. When offered, discount points will reduce the interest rate on the loan by the amount paid. So, for example, if you are obtaining a $200,000 mortgage at a 6 percent rate, you may be able to pay one point ($2,000, or 1 percent) to reduce your interest rate to 5 percent.

Separate your origination points from your discount points. In most cases, the origination points are non-negotiable. These points are based on your credit score and your income. The higher your credit score, the lower your origination points (see Resources for a free copy of your credit report). If your debt-to-income ratio is high, you may end up paying more in origination since your loan will be considered riskier. To determine your DIR, divide your monthly expenses by your monthly gross income. Most lenders like to see a DIR below 40 percent.

Calculate your origination points. For example, if you are obtaining a $200,000 mortgage and you are required to pay 1.5 percent in origination, simply multiply the fractional equivalent of this percentage (0.015) by the total loan amount. In this case your origination is $3,000.

Calculate your discount points, if you choose to pay them. Using the scenario in the step above, say you will be paying half a point to reduce your rate a half a point. Simply multiply your mortgage amount ($200,000) by the fractional equivalent of half a point (0.005). Your discount points will be $1,000.

Add your origination and discount fees together. In this example, your total points will cost you $4,000.