Points – What Are They?

A point is equal to one percent of the loan amount, not the purchase price of the home. If, for example, you take out a $200,000 loan, one point is equal to $2,000. A buyer can usually opt to pay points, typically paid out-of-pocket at closing, on a mortgage to help lower the interest rate of the loan.

Pros and Cons for Paying Points

Deciding whether you would benefit by paying points is best done on a case by case study. Paying points slightly decreases the interest on your loan, creating smaller monthly payments, however, the time you plan to live in your home will best determine whether, or not, it is a good idea.

To illustrate, let’s suppose that you were to take out a loan for $150,000 towards a home. The bank offers you a 30 year loan at 7.5% interest without paying points. Your monthly payments would be about $1049. Or, you could opt, in this case in point, to pay down 2 points ($3000), at only a 7.0% interest rate. This second option would drop your payments by $51 per month, making them $998 each.

In this scenario, you would have to determine how long it would take for you to break even in order to establish whether paying points down was worth your while. To do this, you would divide the amount of money paid for points ($3000) by the monthly savings ($51). The result is about 59, which would be the estimated number of months (just at five years) it would take before you started seeing savings begin to add up.* If you planned on living in that house for at least that amount of time, it might be worth it to you. If, however, you are moving into a home NOT intent on staying there for some time, it is more often than not less practical to consider paying points at closing. It might be better, instead, to use what you would have paid for points towards a bigger down payment on your home to reduce the loan amount as much as possible. It really does depend, though, on what interest rates your lender can provide as options for paying points down, as well as the length of time you intend to live there.

On a positive note, paying points on a mortgage loan is fully tax deductible for the same tax year as your closing date. Different rules apply for refinancing loans, however. If it is a refinancing loan, the IRS will only let you deduct the full amount spread out over the entire period of the loan. For example, if you refinance for a 30 year loan, you can only deduct 1/30 of the amount of points you paid over a thirty year period of time. If you pay the loan off early, you may deduct the remaining amount during that tax year.

*(Note: for simplicity, the above example does not take into account the time value of money, which would slightly lengthen the break-even time.)

 

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