What Are Points and How Do They Work?

Owning a home is a dream that is universal. However, when people start thinking about making that purchase, they hear phrases they may not understand such as paying points. When it comes to points, two questions potential home buyers may have are what are points and how do they work?

The simplest definition is that points are a dollar amount that a homebuyer pays to the lender in order to get a lower percentage for the mortgage. Depending upon who you talk to, paying points for a mortgage may or may not be a good idea.

If you’re looking for a new home, you may think that paying points is an automatic part of the process. The truth is you can choose whether or not to pay them. To determine if paying points is a good option for you, you’ll want to do research before making that decision.

Basically, paying points on the mortgage at closing can allow you to get a lower interest rate. If you choose to go with a “no-points” mortgage, you may be further ahead over the length of owning the home. If you pay the full interest rate, rather than having it lowered with points, you will pay more in interest. The benefit, however, is in the tax deduction you can receive each year.

Another good reason to choose not to pay points is that you can use that money to invest in something that would pay you more than what you’d be saving. In other words, why spend the money up front when you can receive a tax deduction for the interest and then also earn money on your investment?

You may also decide not to pay points if you know you won’t be in the house for long. Some people buy houses to remodel and then re-sell. Other people may have a job that requires them to move frequently. Either of these reasons would be prime reasons to avoid paying points.

Of course, there are also cases in which you may want to go ahead and pay the points. Here’s one example:

You’re looking at a house that cost $200,000. You know you plan to stay in the home for at least ten years. If you choose not to pay points, you may get an interest rate of 6.25%. At this interest rate, your payment would be around $1,231. Paying 2 points ($4,000 up front) gives you an interest rate of 5.75%; your payment would be $1,167. That’s a savings of close to $772 per year.

Now that you know what points are and how they work, you have the knowledge to decide if paying points is right for you. You can choose whether or not using this option will help you reach your dream of owning a home.

IMPORTANT: If you have credit challenges you may still be able to qualify for a mortgage with attractive rates and a small downpayment. Lenders assess risk based on credit , employment and qualifying ratios ( debt to income percentages). Lenders will often assess points to a loan based on the risk of the borrower. The good news is that since points are prepaid interest they are often 100 % tax deductible to you as a borrower.