Home loans are very confusing to most people, even if they have purchased several houses during their lifetime. The various charges tacked onto the loan by the lender add to this confusion. Points are one example of a fee that lenders charge when making a home loan. Though points can be very costly, they also have some financial benefits as well.
Definition
Points in home loans are also called discount points. They are essentially a charge that is prepaid, usually by the mortgage borrower, to lower the interest owed on future payments. Each discount point is equal to 1 percent of the loan amount, according to Investopedia. The financial website BankRate.com says lenders usually charge points as a way to make upfront profit on the loan. Though points are usually paid by the buyer, they can be paid by the seller or split between the buyer and seller.
When Points Are Paid
Though the amount often varies, discount points are paid whenever you purchase a home. If you don't remember ever paying points, but you have a home loan, just look at the HUD closing-costs settlement statement or on a 1098 statement mailed to you by your lender. Points are also paid by the homeowner when refinancing a home, according to BankRate.com.
Tax Breaks
Discount points can be very expensive, though they do provide a tax benefit as well. According to BankRate.com, points are a tax-deductible expense. They state that when it comes to conventional loans, even if you split the cost of points with the seller when you purchased your home, you, as the buyer, may deduct all of the points on your taxes. Lending Tree says points are not always deductible when it comes to refinancing your principal residence, so you need to check with your accountant to make sure.
Benefits of Points
Another benefit of discount points, according to Lending Tree, is the ability to lower your monthly payment. Discount points can be "purchased" at the time that the loan is made. This basically means the buyer can pay more money upfront for the house so that their continual monthly payments are lower. This is a good choice, when possible, because you end up paying less money in interest. Buying extra discount points works well for buyers who have a lot of cash or are looking for the lowest possible monthly payments.
Average Cost
Each point is equal to 1 percent of the loan amount, so for example, if you wanted to borrow $400,000 for a home loan, and the lender was going to charge you two points, you would pay $8,000. Buyers typically pay a few points when they close on a new home, though they can pay more points if they want to lower the principal amount.
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