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What are mortgage points? Should you pay them?

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When people want to find out how much their mortgages cost, lenders often give them quotes that include interest rates and points. This article explains what points are and how to decide whether to pay them.

What is a point?

A point is a fee equal to 1 percent of the loan amount. A 30-year, $100,000 mortgage might have an interest rate of 5 percent but come with a charge of 1 point, or $1,000.

A lender can charge 1, 2 or more points. There are two kinds of points: discount points and origination points.

Discount points

A fee that results in a reduced interest rate on the mortgage. The borrower typically pays zero to 4 discount points. The more points are paid, the lower the interest rate.

Discount points are prepaid interest and are tax-deductible.

Origination fee

A fee charged by the lender to cover the costs of making a mortgage.

Deciding whether to pay

How do you decide whether to pay points, and how many? That depends on a number of factors, such as how much money you have available to put down at closing and how long you plan to live in the house.

Discount points, as prepaid interest, reduce the interest rate. That's an advantage if you plan to stay in the home for several years.

Bankrate's mortgage points calculator will guide you through the decision.

Break-even point

When you pay discount points, you pay a lump sum upfront, and you save a smaller amount of money every month. After a certain period, those monthly savings add up to a bigger sum than the upfront payment. When the accumulated savings exceed the upfront payment, you are said to have reached the break-even point. (In a quirk of the English language, "point" has two meanings when a lender talks of the break-even point after paying a discount point.)

The mortgage points calculator informs you at the top (under the "Calculate" and "View report" buttons) whether your scenario reaches the break-even point. If it says "Buying points can save you" a certain amount over a certain number of years, then you will reach the break-even point by then. If it says "Buying points may cost you" a certain amount over a certain number of years, then you won't reach the break-even point by then, and it's not a good idea to pay discount points in that scenario.

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