Among the decisions a home buyer must make before taking on a mortgage loan are the advantages or disadvantages regarding the paying of points. Beyond the loan term, loan amount, and mortgage interest rate, points play an important part in financing a home as well as affecting the final monthly payment amount. Points are lender-charged fees applied as a condition of loan approval, or allowing more acceptable loan terms. Some lenders apply points as part of closing costs, while others are applied to the loan principle. They are a revenue source for the lender beyond what is earned through the applied interest rate charges.
Discount Points versus Origination Fees
While most lenders assess a loan with one or two points or more, and some with none at all, they can certainly add to the cost of acquiring a loan if applied. Each point represents 1% of the total loan amount, so a single point added to a $200,000 mortgage would yield an additional $2,000 to the cost. The points are structured in one of two ways – discount points or origination fees. The discount type are tax-deductible points applied based on the interest rate, and paid upon loan approval, and will increase if mortgage interest rates decline. Origination points, on the other hand, are charged during the loan closing process, or in advance, are not tax-deductible, and are fees applied to the loan as a lender-charged expense for the loan approval. Your loan term has no bearing on the amount of points charged. So a 30 year mortgage could have the same amount of points as a 15 year mortgage.
Front End or Back End Benefits
The points determine how a particular mortgage loan is structured. The differences come into play when a borrower has little money available toward closing costs, and would opt for a higher interest rate, versus a borrower who is better able to absorb the upfront expense of the discount points. Conversely, if a borrower must maintain a certain monthly payment amount, they can opt for more points in exchange for a lower interest rate to lower the monthly payment. In essence, paying the upfront points fee at closing would reduce the overall pay-out over the life of the loan.