What Exactly are Points on a Home Loan?

Written By: Jenine G. Stuckey on April 12, 2010 No Comment

When you take out a home loan, you will hear discussions about points. There are two types: origination fees (the cost to obtain the loan) are calculated in points, but points may also be required to reduce your mortgage rate.

They are called “discount” points, since they reduce the interest rate on the mortgage. Your interest rate is determined by a number of factors, the most important of which is your credit rating. But the interest rate is paid over the entire life of the mortgage, and so a higher rate can increase the cost of the loan significantly.

If a borrower is willing to pay points to bring the mortgage rate to a “par” rate (the best rate available, usually available for the most credit worthy borrowers), or at least closer to the par rate, he will save a great deal of money over the long term, even though he has to put up more money now.

Well, first of all, you should ask to see if your seller will consider paying these points. This frequently occurs in a competitive real estate market when sellers have to make the sale as attractive as they can.

But if you are paying the points, let’s calculate the costs. If you were offered a mortgage at 6% on a $100,000 home, should you pay 2 points to lower it?

Let’s use an interest rate of 6% on a thirty year home loan that can be reduced to 5.5% if points are paid; how do we know if it is worthwhile?

Your total interest paid on the loan at 6% would come to $115,838.19 and your total payment on the mortgage would amount to $215,838.19, with a monthly mortgage payment of $599.55.

If you pay $2,000 to lower the loan to 5.5%, you have to compare how much you will save, since your monthly mortgage payment will be lowered, in this case to $567.79.

Here is how that calculation comes out: (do the math yourself, if you like): Savings on monthly mortgage: $31.76; Savings in total interest: $11,434.15 Now you know why so many choose to pay points.

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