When you take out a mortgage to buy or refinance a home, you may be required or offered the chance to pay points on the mortgage. A point is 1 percent of the loan value. It is important to understand the meaning and purpose of points. You should know whether you have to pay points or if paying points is actually a benefit.
Mortgage points are used for several purposes in the mortgage origination process. In dollar terms, each point is equal to 1 percent or percentage point of the loan amount. If the new mortgage is for $150,000, each point is worth $1,500. If the mortgage is $500,000, the point value is $5,000.
There are two types of points associated with a mortgage. Origination points are points charged by the lender or loan officer as a fee for processing and getting the loan approved and funded. Discount points are money paid by the borrower to lower the interest rate of the mortgage. Paying discount points lowers the mortgage rate and the monthly payment.
Different lenders can decide whether to charge origination points and how many. A one point origination fee is common. If you find a lender without an origination fee and the same rate, it will save you money. Origination fee points will be higher on a subprime mortgage. Paying discount points will lower the mortgage payment. A lender will offer different interest rates with different levels of discount points. Discount points are considered a prepayment of mortgage interest.
An individual looking at a new mortgage should calculate the time to pay off the cost of the discount points with the amount saved on each monthly payment. The mortgage lender can show the different payment levels for the different amount of discount points. Discount points typically take 10 or more years to be recovered in payment savings. If you plan to stay in your home for a long time, paying discount points will pay off. If you plan to sell the home in a few years, select a mortgage rate with no discount points.
Always check the points included for any advertised mortgage rates. Lenders will advertise rates with an attractive low rate, but the rate requires the payment of several discount points. Compare different lender rates at the same level of discount points. From a borrower's perspective, origination and discount points are the same. A lender who charges one point origination and one point discount fee is the same as a lender with no origination points and a two point discount fee.
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