Points

Definition

Points refer to a percentage of the total loan amount that a borrower can pay to a lender upfront to reduce the interest rate on a mortgage. Essentially, one point is equal to 1% of the loan amount, and paying points can lead to significant savings over the life of the loan by lowering monthly payments.

5 Must Know Facts For Your Next Test

1. Paying points can lower your mortgage interest rate, which in turn reduces your monthly payments and total interest paid over the life of the loan.
2. Typically, each point costs 1% of the loan amount; for example, if you take out a $200,000 mortgage, one point would cost you $2,000.
3. Points can be beneficial for borrowers who plan to stay in their home for a long time, as the upfront cost can lead to greater savings in interest over time.
4. There are two types of points: discount points, which lower your interest rate, and origination points, which are fees for processing the loan.
5. Deciding whether to pay points involves considering how long you will keep the mortgage and whether the savings from a lower interest rate will exceed the upfront costs.

Review Questions

• How do points affect a borrower's decision when taking out a mortgage?
  • Points can significantly influence a borrower's decision regarding a mortgage because they directly affect the interest rate and monthly payments. By paying points upfront, borrowers can secure a lower interest rate, making their monthly payments more manageable. This trade-off requires borrowers to consider their financial situation and how long they plan to stay in their home, as those who intend to remain long-term may benefit more from paying points.
• Compare and contrast discount points and origination points in terms of their purpose and impact on mortgage financing.
  • Discount points are used specifically to lower the mortgage interest rate, thus reducing monthly payments and overall loan costs. In contrast, origination points are fees that lenders charge for processing the loan application and do not affect the interest rate. While both types of points are calculated as percentages of the loan amount, their implications for borrowers differ significantly, as discount points offer potential long-term savings through reduced interest costs.
• Evaluate the implications of paying points on a mortgage in relation to overall financial strategy for potential homeowners.
  • Paying points on a mortgage can be an important part of a homeowner's overall financial strategy. By evaluating factors such as how long they plan to live in the home and their current financial stability, potential homeowners can determine whether paying points will lead to substantial savings over time. A strategic decision to pay for discount points may result in lower monthly payments and less paid in interest over the life of the loan, ultimately contributing to long-term financial health. Conversely, if homeowners anticipate moving within a few years, they may decide against paying points since they might not recoup the upfront costs before selling.

Related terms

Mortgage Rate: The interest rate charged on a mortgage, which can be influenced by various factors including points paid upfront.

Loan Origination Fee: A fee charged by the lender for processing a loan application, which may also be expressed in points.

Amortization: The process of paying off a debt over time through regular payments, which can be affected by the amount of points paid at the start.