Understanding Points

by Matthew Perry
(last updated February 21, 2009)

"Points" is a tricky term. In most popular sports, points are undeniably a good thing, whether they're called goals, baskets, or touchdowns. In mortgage lingo, however, points are a little more ambiguous. Depending on how the word is used and on your preferences, points can be nifty bonuses or the bane of your existence. Almost.

Whichever way they're used, bonus or bane, points do have a standard definition. One point is one percent of your total loan amount; if you're borrowing two hundred thousand dollars, one point is two thousand dollars. Beginning with the negative usage, mortgage lenders charge a certain number of points at the beginning of the loan process as a fee—the number of points changes with the lender and the agreement, but it's always higher if you have bad credit.

However, after all the unpleasantness of obligatory points, you have the option of paying extra points, and there is a good reason to do that. I call these "discount points" because for every one you pay, you get a discount on your interest rate. However, the ratio is not one for one—one discount point does not equal one less interest point. Instead, one discount point is usually equal to about a fourth of an interest point. Most lenders have a cap on the number of discount points you can buy, but lowering your interest rate by even one percent can make a big deal over the life of your loan.

When you're reading the paperwork for your loan, be sure to pay attention to the meaning behind the word 'points.' Also keep in mind what you could do with your money if you don't buy extra points. If you're a hot and heavy investor who has a better use for that money, you may be able to find a more lucrative way to spend your money. Being more of a stock market observer than an actual player, I find the idea of discount points enticing.

Author Bio

Matthew Perry

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