If you haven't bought a home in the past, you might find the concept of "points" – also known as "discount points" – confusing. Every home sale is different, so there is no one-size-fits-all answer when it comes to determining whether you should pay points at the closing of your home sale. Here are the answers to a few questions that you might have about points.
To begin with, what are points?
Put simply, points are a type of pre-paid interest on a loan. One point is the equivalent of one percent of the entire value of the loan. On a $100,000 loan, a borrower can expect to pay $1,000 for one point. Points are paid at the closing of a home sale or refinance transaction.
Who is responsible for paying points?
The answer to this question varies, but paying for points is generally the responsibility of the buyer. However, under certain circumstances, the buyer might negotiate for the seller to pay points as part of the terms of the sale. It is also possible that the buyer and seller may split the cost of the points.
Is paying for points mandatory?
Paying points is not required in every instance. If you feel like you are paying a high interest rate, you might wish to pay points to reduce that rate; if your interest rate is attractive, you may not feel the need to reduce it further. However, it's important to understand the terms of the loan you are applying for. Some lenders might offer an attractive interest rate on a loan but require that the borrower pay points at closing in order to qualify for that rate.
What are the benefits to paying points?
For those homebuyers planning to stay in a home for a long time, paying points up front as pre-paid interest can reduce the interest paid across the long life of the loan. Although paying points raises the upfront costs associated with the loan, the payoff is reduced monthly payments for the long term. Points paid on a residential sale are also tax deductible on an annual tax return for their year in which they were paid.
Are there risks or drawbacks associated with paying points?
Assuming that a buyer has the cash upfront to pay for points, the investment can result in long-term savings. For homebuyers who don't plan to stay in a property for very long, it's important to understand at what point the savings will kick in and translate to long term reduction in cost. Buyers who are planning to turn around a property quickly may not see the payoff of a lower interest rate. Likewise, if a loan is paid off early via refinancing, points are not refundable and client would not see a break even on the upfront cost of points .
A loan officer can help you calculate the savings that will result from each point paid on a loan as well as how long a property would need to be retained in order to see any savings associated with paying points. By talking to your loan officer, you should be able to answer whether "to pay or not to pay" is the right option for you.
