Mortgages Part 6A: Understanding Mortgage Terms - Mortgage Points

When comparing the terms of loans, you will be quoted with interest rates and points. We will start by explaining what points are.

What are mortgage points?

A point is simply a fee equal to 1 percent of the loan amount. A point on a $100,000 mortgage is $1000. A point is usually a lump sum paid when you get your loan, although it can be financed in some cases. 

A lender may charge zero, 1, 2 or more points. There are two kinds of points -- discount points and origination points.

Discount Points

Discount points are actually prepaid interest on the mortgage loan. You can buy points in order to lower your interest rate. The money you paid upfront to buy discount points is tax-deductible.

Example: You want to borrow $200,000 for 30 years. Lender A offers a zero points loan with an interest rate of 5%. Lender B offers a loan with two point at 4.50%

• to pay for the discount point, you will have to pay an additional $4000 (2% of $200,000) to Lender B
• The monthly mortgage payment for Lender A is $1,073.64, and $1013.37 for Lender B. The difference is $60 a month.
• To determine whether paying for discount points is worth the costs, you will need to estimate how long you may be staying at the house. With the savings of $60 month, or $720 a year, you will need to stay in the house for over 5.5 years for the $4000 fee to break even. If you plan to sell your house or refinance before 5.5 years, it is better if you go with Lender A and pay less money upfront.

Origination Points

Original points, or origination fees, are lender or mortgage broker commissions. The points do not lower your interest rate or apply to any other costs of your loan. Your mortgage broker or loan officer works on commission. The original points is how they get paid, and is a necessary payment for the service you receive.

The origination fee is tax deductible if it is used to obtain the mortgage and not to pay other closing costs.

To summarize, it is usually not beneficial to pay for discount points if you only plan on keeping the house and the mortgage for a very short time. Discount points are beneficial if you plan to stay in your house for a long time, and rates are already historically low, which means you will not plan to refinance soon.

But paying for discount points does require more upfront money from you. If you do not want to pay extra money out of pocket for discount points and origination fees, you may ask for "no cost loans" that do not include a loan origination fee. Usually this means your interest rate will be higher as a result, all else being equal, because the lender is paying the commission for the loan officer themselves.

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