How Are Points Determined in a Mortgage?

by Chris Joseph, Demand Media

    If you're considering or already in the process of buying your first home, your head may feel like it's about to explode due to a severe case of "information overload." Getting a mortgage loan is probably the most daunting task associated with the home-buying process. An important decision you'll face is whether to make use of mortgage points offered by your lender.

    What Are Points, Anyway?

    Unlike football or basketball, there is no scoring involved with mortgage points. Instead, mortgage points are actually charges you pay upfront when obtaining a mortgage loan in exchange for a lower interest rate. Each point is equal to one percent of the amount of your mortgage loan. For example, if you borrow $200,000 at six percent interest and you pay two points, you will pay $2,000 at closing. In return you will receive an interest rate of four percent instead.

    When Should You Pay Points?

    Paying points can make sense if you plan to stay in your home a long time and are taking out a 30-year fixed-rate mortgage. While you will be paying more money upfront when you purchase your home, you will more than make up for this short-term expense with the lower amount of interest you'll pay over the life of your mortgage. As of 2010, you may also be able to deduct the cost of the points on your federal income tax return.

    Number of Points

    Most lenders offer the option to purchase as many as four points if your budget allows. When determining the number of points that is right for you, take into consideration factors such as your closing costs and the possible impact that the points will have on your tax situation. To help you determine the right amount of points for you, use a points calculator such as the one located in the Resources section.

    Negotiating Tactic

    You can use points in your favor as a negotiating tactic when buying your home. If you're dealing with a motivated seller who needs to unload the property quickly, see if she is willing to absorb all or a portion of the cost of the points. You'll gain the advantage of the lower interest rate while potentially reducing your closing costs.

    About the Author

    Chris Joseph writes for newspapers and online publications, covering business, technology, health, fitness and sports. He holds a Bachelor of Science in marketing from York College of Pennsylvania.