Lender Points Can Save You Money

When people want to find out how much their mortgages cost, lenders often give them quotes that include both loan rates and "points." What exactly is a point? A point is a fee equal to 1% of the loan amount. A 30-year, $150,000 mortgage might have a rate of 7% but come with a charge of 1 point, or $1,500.

A lender can charge one, two, or more points. There are two kinds of points: discount points and origination points.

Discount points: These are actually prepaid interest on the mortgage loan. The more points you pay, the lower the interest rate on the loan and vice versa. Borrowers typically can pay anywhere from zero to three or four points, depending on how much they want to lower their rates. This kind of point is tax-deductible.

Origination points: These are charged by the lender either to cover the costs of making the loan or to boost profits. They are not tax-deductible and serve no real purpose for borrowers. Most buyers try to avoid origination points, but may be willing to pay discount points to reduce the interest rate on their loan.

How do you decide whether to pay points, and how many? That depends on a number of factors, such as how much money you have available to put down at closing and how long you plan on staying in your house. Points as prepaid interest help reduce the interest rate. If you plan to stay in your home for a while, it may be worth reducing the interest rate by paying points.

The best option depends on your individual needs, but, if you need the lowest possible closing costs, choose the zero-point option on your loan program.

By the Numbers

A lender might offer you a 30-year fixed mortgage of $165,000 at 6% interest with no points. The monthly mortgage principal and interest payment would be $989. If you pay two points at closing (that's $3,300) you can bring the interest rate down to 5.5%, with a monthly payment of $937. The savings difference would be $52 per month. But it would take 64 months to earn back the $3,300 spent upfront via lower payments. If you're sure you will own the house for more than five years, thus reaching your breakeven point, you will save money by paying the points. After the breakeven point, the savings in interest will be substantial.