Mortgage Points Explained

If you've done some research on Mortgages, you probably have stumbled upon the term points.  You may be wondering about the purpose of points.  Do you want them?  Do you want to avoid them?    Mortgage points exist to give borrowers more options.   I'll explain how in a moment. 

To start, let's break down one point.  If you see one point, it means 1% of the mortgage.  So, on a $100,000 mortgage, one point would equal $1,000.  So how do buyers and lenders implement points?

Positive Points (Discount Points)
The purpose of positive points is to lower your interest rate.  This  means you have to pay more upfront to reduce your interest rate.  If you are planning on getting a 30 year mortgage, a reduced interest rate can go a long way.  For example, if you're applying  for a $100,000 mortgage and they give you a 5% interest rate, you may be given the option of paying 2 discount points to reduce the the interest rate to 4.75%.  This means you would have to pay $2,000 to get this rate. 

Negative Points
Negative points are essentially the opposite of positive points.  In this transaction, banks offer to pay you points in exchange for higher interest rates.  To explain this better, lets look at a scenario:  Joe and Jane want to buy a house.  All of their money is going towards the down payment and they don't have quite enough for closing costs.  The  bank then offers 2 points in exchange for .25% higher interest.   

Which is better?
Some of you math nerds out there would argue that lower interest rates would be a better, long term decision.  While this is a valid argument, it's not quite that simple.   Negative points can be a great option for buyers that don't quite have enough cash to pay for closing costs.  Also, you could almost include a higher interest rate as a tax planning strategy.  The higher interest means you will be able to write off more money on your taxes and get a higher return.  

Finally, I would suggest considering both options for the long term.  How long do you plan on having the mortgage, does it pay off to receive money on the front end in exchange for a higher interest rate?  It could pay off if  you aren't planning on keeping the mortgage for a long time.   Or, if you are in it for the long haul, consider how many years of interest savings would it take to pay off the points spent to attain the lower interest rate.

If you have any other questions feel free to comment or contact me directly.  

Sources:  Mortgage101.com, Fool.com, and Realtor.com