What Do Points Mean on a Mortgage?

Discount points help you save on interest.

Discount points help you save on interest.

When you agree to the terms of a mortgage, you do so knowing that you are committing yourself to decades of financial obligation. While mortgages act as the bridge to homeownership for many individuals, they are also a significant amount of debt paired with stringent repayment terms and interest. Depending on your specific financial profile, you may be offered one of several interest rates provided by lenders. In some situations, you may be able to use "points" to buy down your interest rate and, consequently, lower your overall debt burden. A point is a specific sum of money derived from the overall size of your loan.

Tip

Mortgage points are commonly divided into two categories, those being discount points and origination points. Whereas discount points allow borrowers to lower their interest rate, origination points are primarily intended as a means to compensate loan officers.

The Basics of Mortgage Points

A mortgage point has no absolute monetary value. When mortgage lenders offer points for purchase, the point is valued at 1 percent of the total borrowing amount. The monetary value of a mortgage point increases as the size of the mortgage increases.

As an example, imagine that you have applied for a mortgage loan of $250,000. If you are approved for the loan, a single point will be valued at 1 percent of $250,000, or $2,500.

Points can either be assigned by a lender as part of a mortgage's closing costs or voluntarily purchased by a borrower as a means to reduce their overall borrowing costs. It is important to realize that a point is nothing more than a unit of measure.

Exploring Mortgage Discount Points

Discount points can help borrowers significantly improve the terms of their lending at the onset of their borrowing period. In essence, a discount point acts as a form of initial upfront interest payment. As you continue to purchase discount points, you will increase the amount of future interest that has already been paid, which, in turn, will lower your effective interest on the loan.

Depending upon your specific lender, the terms attached to discount points can vary considerably. It is generally expected that a discount point will be the equivalent of an interest rate reduction in the range of .125 to .25 percent. Again, the technical details of the discount point are the responsibility of the lender, not the borrower.

Although some may find it worth their time and money to purchase a large number of discount points, lenders will almost always limit the number of points that are available for purchase. As a general rule, borrowers should consult with their lender to determine what specific options may be available to them in regard to buying discount points.

Understanding Mortgage Origination Points

In some situations, a borrower will pay mortgage origination points to their loan officer as a form of compensation for the work they have done in supervising the loan approval process. Whether or not origination points must be paid will depend entirely on the terms dictated by the supervising loan officers. Just as with discount points, origination points are equivalent to 1 percent of the total mortgage sum.

Mortgage applicants would be smart to discuss origination points with their desired lender before entering into the application process. This will help ensure that they have all of the information they need to make the most informed decision possible.

Video of the Day

Brought to you by Sapling
Brought to you by Sapling
 

About the Author

Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community.

Photo Credits

  • hipoteca americana image by caironbohemio from Fotolia.com