A point equals one percent of the principal amount of a mortgage. If the mortgage is $200,000, each point is $2,000. By paying more points on a loan, homeowners can negotiate a lower interest rate, which will then lower their monthly payment.
Each point you pay can reduce your interest rate anywhere from one-eighth to one-quarter of a percent. The discount depends upon the lender and the daily fluctuations in the mortgage market. You can purchase up to four discount points or even more. Keep in mind that discount points are tax deductible.
Origination points is actually a fee that you're charged when you take out a mortgage. These points do not provide any value and should be avoided if possible. If you have a bad credit rating, the lender may require these points in order to make a loan.
There are two major points to consider when thinking about whether to purchase discount points. The first, of course, is whether you can afford them. Points are paid up front, just like the down payment, which is usually a requirement. Points, being optional, do not have to be purchased. After paying the down payment, you may not have enough cash on hand to pay for them.
Secondly, you'll want to determine when you'll break even on the points. It's a financial decision, after all. Let's say your mortgage is $100,000 at 6 percent, your payment is $599.55 per month. If you purchased three discount points, your interest rate would drop to 5.25%, and your monthly payment would be $552.20 per month. The points would cost you $3,000 and you'd realize a savings of $47.35 per month. Your break-even point is 63 months on your purchase. Considering that the standard loan is 360 months, if you plan to stay in your home for many years, you would realize significant savings.
For more information on points, talk to your mortgage lender or real estate agent.