When you are shopping for a mortgage you will hear the term points and learn that they are an expense that you have to pay up-front, at closing to kick off your home loan. So the question is: Why pay points on a mortgage? This is an up-front fee that is common practice but it can be negotiated out of your loan if you are willing to accept more expensive terms. Once you understand mortgage points you will realize that they give you some flexibility in how you structure your mortgage.
What Are Mortgage Points Anyway?
When you take on a home loan, your lender earns income from you in the interest payments. In theory, this could be done in many ways, such as a balloon payment of all the interest at the end. Well, that would be expensive because you would then have to find some way to fund that very large future payment. You could pay all of the interest in advance, but again not an appealing option.
The easiest way to repay a home loan is with an amortizing loan where you pay interest on the remaining principal of the loan each month and part of the principle. This works out for everyone, the bank makes some interest and consumers get reasonably affordable home loan payments.
Pay Points And Save Interest
But banks like to get paid sooner rather than later and so they are willing to trade a discount on your interest in return for an small-ish up-front payment. This has often worked out even better for all parties involved then just repaying the interest in the payments. This has become a standard practice in the home finance industry. This payment is referred to as points because it will be a small percentage of the principle, usually around two to four percent.
You do not have to pay points but the lender will demand higher interest payments for a no-points loan. The higher the points you pay the lower the interest rate for your monthly payment. In fact, you might be able to negotiate negative points where the lender pays you!
Negative points might be helpful when you need cash at closing to to cover costs that would otherwise be unaffordable. But watch out for the higher interest rates that they will want to charge you each month.
Paying points on your home loan is not mandatory but it is a common practice in mortgage lending. It might be worth it if you can afford it because it will save you some on interest payments. If you are cash poor you can save on closing costs by taking a no-points loan at higher interest. If you have the cash it might save you more interest than if you added it to your deposit. Make sure that you know all of your options and discuss it in detail with your lender before you make a final choice.