Mortgage Points- Pro's and Con's

Mortgage points are often a confusing aspect of home lending. Getting a first-time mortgage or even a refinance just by itself can be a major undertaking. There is a lot of financial information to grasp and very few places to turn for help in doing so. Sometimes it's hard for many home buyers to work out what is the best option to take.

Many potential borrowers find themselves wondering "what are points on a mortgage," how do they work and why they should be considered. Let's take a look at points and their pros and cons.

First off, a mortgage point, or discount point, is nothing more than one percent of the loan amount. When "points are paid" upfront, it means that a fee is being paid to the lender in advance of the loan. Generally, this maneuver results in a lower interest rate being charged, since the lender is getting part of its interest payment in advance. This payment does not reduce the principle amount of the loan.

For example, if a mortgage is set for $100,000 at 5 percent and 2 points, the borrower will need to pay $2,000 to the lender at the time of closing to enjoy that 5 percent rate. Most lenders offer borrowers the ability to choose a higher interest rate instead of points, which makes it easier to obtain a loan with little or no money down.

The pros and cons of going with points will depend on the individual loan and the personal financial and credit situation of the buyer, but there are some generalizations that can be made in most cases. They include:

Pros

Can result in a tax deduction. The IRS sees points, in many cases, as an advanced interest payment. This means these fees might be deductible from income taxes. The rules about how much or how little can be claimed and in what years should be reviewed carefully. On mortgage refinances, for example, the deduction might not be allowed in the year the points are paid.
Can result in a lower end price. If a mortgage is going to be kept for the duration, the end result of buying points on the front end can be great on the back end. When all is said and done, there can be some substantial money savings. It is wise to ask and see a truth in lending statement workup for both scenarios, with points paid and without. This will help show the true bottom line.

Cons
The upfront costs for buying a home are often greater when points are included in the mix. On the converse, if points are excluded, a person might have to pay later, but they can enjoy the home in the meantime.
Lost money on resale. If the intent is to keep the home and mortgage for only a short period of time, paying points probably isn't the wisest choice. The few dollars saved in monthly fees likely won't add up to cover the costs in points if a mortgage is closed out within a year or two of origination.
Making the choice between points or no points can be a little confusing. It's best to ask your lender to see a full breakdown of both options before moving forward.