A point is one percent of the loan amount, paid at closing: discount points buy a permanently lower interest rate and pay for themselves only after the monthly saving adds up to their cost, while origination points share the name but are a fee for making the loan and buy nothing.
The word does two jobs, and the loan estimate does not always separate them for you. Both kinds of point are money paid to the lender at closing, and both are quoted as a percentage of the loan rather than of the price. Only one of them changes the interest rate, and the arithmetic that tells you whether it was worth paying is a single division that anyone can do before signing.
One point is one percent of the loan, not of the price
On a $450,000 purchase with 20 percent down, the loan is $360,000 and one point is $3,600. On the same purchase with 5 percent down the loan is $427,500 and the point is $4,275. The price is not in the calculation at all, which is why two buyers of the same house can be quoted different dollar amounts for the same point.
Points are paid in cash at closing or covered by a seller or lender credit. They are not rolled into the loan on a purchase in the way an FHA upfront premium is, so a point is money that has to be there on the day.
Discount points and origination points are different products
A discount point buys a lower rate. How much lower is set by the lender's rate sheet on the day and moves with the market, but the working rule of thumb is roughly a quarter of a percentage point per point paid, and it is worth checking against the actual quote rather than assuming.
An origination point is compensation for making the loan and does not touch the rate. On the loan estimate both appear in section A, Origination Charges, on page two, with the discount point shown on its own line as a percentage of the loan amount and labelled as points. That line is the check: if a quote is cheaper than another on rate, section A is where the reason usually is.
The break-even is one division
Take a $360,000 loan at 6.5 percent over 30 years. Principal and interest are about $2,280 a month. Buy one point for $3,600 and suppose it moves the rate to 6.25 percent: the payment falls to about $2,220, a saving of about $59 a month. Divide $3,600 by $59 and the point has repaid itself in about 61 months, a little over five years.
That number is the whole answer, and it cuts both ways. Sell or refinance in year three and roughly $1,500 of the point was never recovered. Hold the loan ten years and the point returned about $7,000 against its $3,600 cost, and over a full 30-year term the interest saved is more than $21,000. Nobody knows in advance which of those happened, which is why the honest form of the question is how long the loan is likely to last rather than whether points are good.
How points are treated at tax time
Points paid to obtain a mortgage are prepaid interest, and IRS Publication 936 sets the conditions under which they can be deducted in full in the year paid rather than spread over the life of the loan. The tests include that the loan is secured by a main home, that charging points is an established practice in the area, that the amount charged is not more than is generally charged there, that the points are shown as points on the settlement statement, and that the cash brought to closing at least covers them.
Points on a refinance generally do not meet those conditions and are deducted over the life of the loan instead. Origination charges that are really fees for services are not points at all for this purpose. None of this is tax advice and the pages here do not give any: a tax preparer applies Publication 936 to a specific settlement statement.
Questions people ask
Do points lower the loan balance?
No. A point is a fee paid at closing that changes the interest rate; the principal balance is the same the day after closing as it would have been without it. What falls is the interest charged on that balance, and with it the monthly payment.
Can a seller pay the points?
Often, within limits. Seller-paid points are an interested-party contribution, and the agencies cap those by loan-to-value on conventional loans, so how much a seller can put toward points depends on the down payment as well as on what the seller agrees to.
What is the opposite of paying points?
A lender credit, sometimes called negative points: the borrower accepts a higher rate and the lender pays part of the closing costs in exchange. It is the same rate sheet read in the other direction, and the break-even arithmetic works the same way in reverse.