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What Are Mortgage Points?

By Arvin Sahakian · Apr 17, 2015 · Mortgage

What Are Mortgage Points?

Image courtesy of Flickr, David Goehring

Understanding what mortgage points are, how to calculate them and how they affect you is the key to choosing the right mortgage with the best interest rate and terms.

The idea of mortgage points can seem quite overwhelming at first. However, once you know exactly what mortgage points are and understand the different types that are available, you will know how to make them work for you instead of being intimidated by the concept.

Mortgage Points Defined

Mortgage points are fees charged by a mortgage lender or broker, with each point being equal to 1% of the loan amount. There are two different types of points, origination points and discount points. They each serve different purpose, even though the way you calculate them is the same.

Discover the two different types of points and how they affect your mortgage loan. Understanding points can help you make better decisions about your home purchase or refinance.

Origination Points

Origination points are a type of fee that borrowers pay the lender or broker to handle all of the approval stages and paperwork involved in the deal. This includes evaluation, processing, approval and funding of the loan. The origination fee is calculated using a "point method." It could be 1 point (1% of the loan), 2 points (2% of the loan), and so on.

For Example:

If you have a $350,000 loan amount, then a 1 point origination fee (equal to 1%), would cost you $3,500.

This type of fee is calculated based on your credit history as well as the qualification requirements of the lender, which is why you will see variations in origination fees.

Discount Points

Discount points are different from origination points. They are not a fee, but are instead a type of prepaid interest that borrowers pay. A borrower purchases points which lower the amount of interest they will have to pay on future mortgage payments.

Typically each discount point costs 1% of the loan amount, and each point typically lowers your interest rate anywhere from one-eight (0.125%) to one-fourth (0.25%) of a percentage from the interest rate you initially qualified for.

For Example:

If you initially qualified for a 4.00% interest rate on a $350,000 loan, then you can pay 1% of the loan amount ($3,500) to lower you interest rate from 4.00% to anywhere from 3.875% to 3.75%.

The difference will vary depending on which lender you use, and the difference in monthly payments can be significant, so be sure to take your time when making a decision on whether or not to purchase discount points.

Are Mortgage Points Tax Deductible?

While origination points are not tax deductible, the discount points you pay are tax-deductible if they meet a certain list of requirements outlined on the IRS website. The list of requirements are:

  1. Your main (primary) home secures your loan.
  2. Paying points is an established business practice in the area.
  3. The points paid were not more than the amount generally charged in the area.
  4. 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 them.
  5. The points paid were not for items that are usually listed separately on the settlement statement such as appraisal fees, inspection fees, title fees, attorney fees, or property taxes.
  6. The funds you provided at or before closing, including any points the seller paid, were at least as much as the points charged. You cannot have borrowed the funds from your lender or mortgage broker in order to pay the points.
  7. You use your loan to buy or build your main (primary) home.
  8. The points were computed as a percentage of the principal amount of the mortgage.
  9. The amount shows up clearly as points on your settlement statement.

Understanding Mortgage Points

Now that you understand what mortgage points are, and the two different types, you can follow along when your lender starts talking about the various options available to you. Spend some time crunching the numbers and perhaps using a closing cost calculator so that you can narrow down the best options for you more easily.

Homebuyers and borrowers looking to refinance who do their research ahead of time are less likely to find themselves in a situation they cannot handle. There are countless instances where people get too excited about the buying or refinance process and dive in by taking the first mortgage offered to them. Having an understanding of mortgage points will help you to make the best for you and your family.

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