The term mortgage points is used to describe the upfront fee lenders place on a mortgage to reduce the interest rate charged the borrower. The payment of points results in the prepayment of interest charges, which lowers the overall risk of the loan.
Money Due at Closing = (Points / 100) x Dollar Value of Mortgage
Mortgage points are paid at the time of closing, and are usually stated as a percentage of the loan amount. Points represent a prepayment on a loan. They are used to reduce the loan’s risk, and result in a lower rate of interest charged to the borrower. Since mortgage points are a prepayment of interest on a loan, they are a deductible expense on federal income tax returns.
Points are included in the calculation of the annual interest rate, or APR, which can be used to compare loans. The relationship between APR, points, and interest can be seen in the following example for a 30 year fixed rate mortgage:
The borrower should keep in mind that points are used to reduce interest payments over the entire lifetime, or term, of the loan. If the homeowner knows they are moving or refinancing a loan in the near term, the benefit of the points is lost, as well as the money paid for the points.
Ann is buying a home and after considering the money she has available to pay her closing costs; she decides to secure a mortgage that requires the payment of 1.5 points. Ann is going to purchase a home for $400,000, and is able to make a down payment of $100,000; therefore, Ann’s mortgage will be $300,000.
The money needed at the home’s closing to pay the mortgage points would be:
= (1.5 / 100) x $300,000 = 0.015 x $300,000, or $4,500