What Every First Time Home Buyer Needs to Know About Points
11/16/2010 Mortgage points can be confusing. We've developed an in-depth explanation of what all first time home buyers need to know about points before taking out a mortgage.
In mortgage terms, a "point" is a sum of money paid up front, at the closing of the mortgage deal, in exchange for better loan terms. Points lower the lender's risk. When more money is paid to the lender up front, the loan itself is smaller and less riskier. This allows the lender to offer more favorable rates and terms to the borrower.
A point is equal to 1% of the total loan amount. There are two kinds of points.
Discount Points
Discount points are designed to lower the interest rate on the loan, as described above. Discount points are essentially loan interest paid up front, in a single lump sum, before accrual. As a result, points are typically tax-deductible.
For example, if a borrower is taking out a home purchase mortgage for $200,000 at an interest rate of 4.5%, he or she could pay the lender a point, equal to $2,000, in order to have that interest rate reduced to 4.475%. This is called "buying down" a loan. The lender must agree to this, of course, and all lenders differ on what they're willing to allow. But generally, borrowers can access the lowest mortgage rates by paying one or more points up front.
Origination Points
If your lender requires you to pay origination points, don't worry. You'll probably notice that this same lender isn't charging you an origination fee. This is because origination points, when paid, simply amount to the cost of the origination fee. They're just calculated differently. Origination points are far less common that discount points an they're not always tax-deductible.
Whether or not it's a wise idea to pay points depends on how long you intend to keep your mortgage and how much cash you have available. If you plan to keep your mortgage for a significant length of time, it's probably a good idea to get the lowest rate you can by paying points. This is especially true if you have a poor credit score. Points can help you access a low mortgage rate in spite of negative credit history.
If, however, you don't plan to keep the mortgage long or you simply don't have cash on hand, points aren't a good idea. Talk with your lender and make the decision that best suits your current financial situation and your future goals.
