What are "points"?

Several people have written to ask about points.

Simply put, 'points' are fees the borrower pays the lender when the loan is closed. Each 'point' is equal to 1% of the loan. On a $100,000 loan, for example, 3 points would equal $3,000. When you pay points, you are paying interest up-front to lower the rate on your mortgage. Not all loans require you to pay points.

Some of you have asked if it is smarter to pay the points to get a lower payment on your mortgage. Typically, I recommend against paying points on a mortgage. There are severl reasons for this:

First, it usually takes about seven years before the amount you save on your mortgage payments equals the amount you paid in points. Most people will either sell their home and move or refinance their mortgage within seven years. In these cases, the money paid in points is gone and, in my opinion, wasted.

Second, you can usually save more on monthly payments by applying the money you would have spent on points to other higher-interest debt such as credit cards. The reduction of payments per month should be more than the reduction in your mortgage payment would be and, credit card interest is not tax-deductible whereas mortgage interest is.

Third, may people purchase a home and end up running up their credit card bills to furnish and decorate the home. By using the money that would otherwise go toward points, you can apply that to the furnishing and decorating and save on your credit cards.

There are some situations where it is advantageous to pay points. For instance, if the seller or builder are willing to pay points for you, take it. You get the lower payment and also get to deduct these points on your tax returns*.

All situations are different and there may be reasons to pay points. An experienced loan professional can show you the pros and cons of paying points or applying that money elswhere to better your financial position.

*Consult your tax advisor to see how this relates to you.