What Are Points in Lending?


A Little Mortgage Quiz

Points are:

a) charges paid to obtain a home mortgage
b) gross profit for the originator of the loan
c) up-front mortgage interest fees to reduce the interest rate
d) each equal to 1 percent of the total loan amount
e) loan origination fees
f) charged by a lender to raise the yield on a loan 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
g) come in two varieties
h) all of the above

If you answered (h), you are correct.

Points are all those things and more. They are often used to cover a lender’s overhead—salaries, building leases, employee benefits, and other unexpected expenses. Generally, paying one point should lower the interest rate on a loan ¼ percent, two points ½ percent and so on. A rule of thumb is: a no-point loan will have a higher interest rate than a loan with points. Paying points on your mortgage now means you’ll pay less interest later. Lowering the rate reduces your monthly principal and interest payment. In essence, points equal prepaid interest.

With conventional loans, the borrower or lender can pay the points or they can agree to pay half. On HUD and VA loans, borrowers can’t legally pay points—the seller is required to pay.

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Discount Points

There are two types of points. Discount points are prepaid interest on your mortgage loan—you’re basically paying your finance charges in advance. Discount Points are used to "buy" your interest rate lower. This is known as a rate "buydown." One Discount Point will lower your fixed interest rate by .250 percent or your adjustable rate by .375 percent. These points lower the interest rate for the entire term of the loan.

The more points you pay, the lower the interest rate on the loan, and the fewer you pay, the higher the interest rate. Paying discount points is a good idea if you plan to live in the house for a long time.

You can deduct the points in the year that they are paid, as long as the following requirements are met:

•  You are legally liable for the debt and the loan is secured by your home.
•  Paying points is an established business practice in your area.
•  The points paid were not more than the amount generally charged in that area.
•  You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay the points.
•  The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
•  You provided funds at or before closing, which were at least as much as the points charged, not counting points paid by the seller. You cannot have borrowed the funds from your lender or mortgage broker.
•  You use your loan to buy or build your main home.
•  The points were computed as a percentage of the principal amount of the mortgage, and
•  The amount is clearly shown on your settlement statement.

Origination Points

Origination points are charged by your lender to evaluate, prepare, and submit a proposed mortgage loan (the costs of making the loan) or to boost profits. Some loan officers’ compensation is based on origination points. Often lenders add origination points into their quoted points while others add an origination point in addition to their quoted points. Where discount points serve the borrower by lowering the interest rate, origination points are gross profit for the lender. They are not tax-deductible.

It takes about five years on a 30-year loan to recoup the cost of the points paid provided each point lowers your rate ¼ percent as described above. If the drop in rate is not ¼ percent for each point paid, the amount of time it takes to recoup the points is longer.

For more information, or if you are interested in purchasing a new home, please contact me!