What are Points in Real Estate?
Points, commonly known as discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate. Each point costs 1% of the loan amount and significantly influences the overall cost and effective interest rate of the mortgage.
Key Characteristics
- Cost: Each point equates to 1% of the loan principal amount.
- Purpose: Points can either be origination fees paid to cover the lender’s processing cost or discount points aimed at reducing the mortgage interest rate.
- Impact: Paying points increases upfront closing costs but decreases the monthly mortgage payment and overall interest paid over the life of the loan.
Example
Consider a borrower applying for a $50,000 mortgage:
- Origination Fee: If the lender charges one point as an origination fee, the borrower must pay an additional $500 at closing. Consequently, the borrower receives $49,500.
- Discount Points: Additional points can be paid to lower the interest rate, thus decreasing the monthly payments and total interest over the loan term.
Frequently Asked Questions
1. How do points affect the interest rate?
Discount points lower the mortgage interest rate. Each point typically decreases the rate by about 0.25%, but this varies among lenders.
2. Are points tax-deductible?
Yes, points paid on a mortgage for a primary residence are generally tax-deductible, but specific conditions must be met. It’s advisable to consult with a tax advisor.
3. How do I determine if paying points is beneficial?
The decision depends on how long you plan to stay in the home and how much you can afford for upfront costs. If you plan to live in the home for several years, paying points can save money over time.
4. Can points be financed into the mortgage?
In some cases, points can be rolled into the mortgage, but this increases the loan amount and possibly the monthly payments.
5. What’s the main difference between origination points and discount points?
Origination points are fees paid to the lender for processing the loan, whereas discount points are fees paid to lower the interest rate.
Related Terms
- Mortgage: A loan secured by real property, through which the borrower is obligated to make a predetermined set of payments.
- Interest Rate: The proportion of a loan charged as interest to the borrower, typically expressed as an annual percentage.
- Closing Costs: Expenses over and above the price of the property in a real estate transaction, often including origination fees, discount points, and prepaids.
- Yield: The return on investment for a mortgage lender, impacted by the interest rate and fee structure.
- Principal: The original sum of money borrowed, lost, or invested.
Online Resources
References
- Federal Housing Administration. “Buying a Home.” HUD.gov.
- Consumer Financial Protection Bureau. “Mortgage Points Explained.” CFPB.gov.
Suggested Books for Further Studies
- “The Book on Mortgage Planning: Planning Tips for a Bear Market” by Rob Kanyur
- “All About Mortgages: Insider Tips to Finance or Refinance Your Home” by Julie Garton-Good
- “Mortgages For Dummies” by Eric Tyson and Ray Brown
Real Estate Basics: Points Fundamentals Quiz
### What do points represent in a mortgage loan?
- [ ] A percentage of the property value.
- [ ] A measured property tax benefit.
- [x] Fees paid to the lender to lower the interest rate.
- [ ] A part of monthly property insurance.
> **Explanation:** Points are fees paid to the lender at closing to reduce the interest rate or cover origination costs. Each point equates to 1% of the loan principal.
### How much is each point worth?
- [ ] 0.5% of the loan principal.
- [ ] 2% of the loan principal.
- [ ] 1.5% of the loan principal.
- [x] 1% of the loan principal.
> **Explanation:** Each point equals 1% of the loan principal amount.
### What is the primary benefit of paying discount points?
- [ ] It reduces the loan term.
- [ ] It increases the loan principal.
- [x] It lowers the mortgage interest rate.
- [ ] It eliminates property taxes.
> **Explanation:** Paying discount points reduces the mortgage interest rate, which can lower monthly payments and the total interest paid over the loan term.
### Are points tax-deductible?
- [x] Yes, typically for primary residence mortgages.
- [ ] No, never.
- [ ] Only for commercial properties.
- [ ] Only if the loan term exceeds 30 years.
> **Explanation:** Points paid on a mortgage for a primary residence are generally tax-deductible, but specific conditions apply.
### Which type of point covers lender processing costs?
- [ ] Discount points
- [x] Origination points
- [ ] Refinance points
- [ ] Equity points
> **Explanation:** Origination points are fees paid to the lender for processing the mortgage loan.
### What should a borrower consider when deciding to pay points?
- [ ] Property location
- [x] Duration of stay in the home
- [ ] Type of flooring
- [ ] Landscaping quality
> **Explanation:** A borrower should consider how long they plan to stay in the home to determine if paying points will be cost-effective over time.
### If a lender charges two points on a $100,000 loan, how much is paid in points?
- [ ] $100
- [x] $2,000
- [ ] $200
- [ ] $1,000
> **Explanation:** Two points on a $100,000 loan amount to $2,000, as each point is 1% of the loan principal.
### Can paying points increase the loan amount?
- [x] Yes, if financed into the mortgage.
- [ ] No, points are only paid separately.
- [ ] Only if the property is rural.
- [ ] Only if the borrower has excellent credit.
> **Explanation:** Points can be financed into the mortgage, increasing the loan amount and possibly the monthly payments.
### Why might a lender charge additional points?
- [ ] To reduce property value
- [ ] To delay the loan closing date
- [ ] To save on lender's taxes
- [x] To align with current market interest rates
> **Explanation:** Additional points may be charged to adjust the loan yield to reflect current market interest rates.
### Which organization provides guidelines on tax-deductibility of points?
- [ ] Federal Reserve
- [ ] Department of Education
- [x] Internal Revenue Service (IRS)
- [ ] Local Municipalities
> **Explanation:** The Internal Revenue Service (IRS) provides guidelines for the tax deductibility of points on a mortgage.
