What Are Points and Why Should I Purchase Them?

Are you looking to refinance your home or mortgage? Are you looking at an initial mortgage where points were offered to you? Then you probably ought to know a thing or two about points-and if you don’t, then you should read further, because learning about points could save you money.

Points are an option available to both initial mortgages and mortgage refinances. They exist to provide the lender with more profit-though you may make out better in the end. Purchasing one point costs the same as 1% of the total principal amount of the loan, but it reduces your interest rates to purchase them. So whether or not you earn a profit really depends on how long you plan to stay in your home.

Say a lender offers you two choices: one $80,000 loan at 7% fixed interest with a 2-point purchase-costing an extra $1,600 due at closing; or one $80,000 loan at 8% fixed interest with no points available. It would take you about two and a half years to earn back what you spent at closing on the points. If you plan to stay at your home for longer than that, you can even earn a profit from purchasing the points. However, if you plan to stay at your home for less than two and a half years, then you should go with the second option-because you would not earn back the $1,600 spent at closing.

There are, of course, other factors to consider when looking at purchasing points to refinance your home or mortgage. Let’s use the same example from before-two points costing you $1,600 and you’re even planning to stay for five years, earning you a solid profit. But what if you took that money and invested it at an 11% interest rate? If you bought the points, you would make a profit of $800 over the five years, but if you invested the same money, you would make a profit of $880. So you have to compare your options and decide what course of action is the best and most profitable-simply choosing a profitable course may not be the most helpful in the long run.

Points can also be deducted from your income tax returns. But you need to be careful-if you’re refinancing mortgage loans, it can be deducted with the down-payment, but if you’re refinancing your home, this is considered prepaid interest-so you have to deduct it over the term of the loan, rather than all at once at closing. You should discuss points with your tax advisor or accountant to better understand this process.

So now you know a little more about points. They could help you, but they might not; they might speed up the process of getting out of debt, or they might just make you lose money. Remember: it all depends on how long you’re staying in the home. Just keep these things in mind when you’re looking to refinance.