What are points in mortgage financing and how do they affect loan costs?

• A. Points are prepaid interest to lower the note rate; paying points increases upfront costs but reduces ongoing payments; break-even analysis is used.
• B. Points increase the note rate.
• C. Points are refundable fees.
• D. Points have no effect on rate.

Answer: (D)

Points are prepaid interest paid at closing to lower the mortgage’s interest rate. Each point usually equals 1% of the loan amount, and when you pay points, your upfront costs rise, but your monthly payments drop because the rate is reduced.

Lenders and borrowers use break-even analysis to decide if paying points is worth it. You compare the upfront cost of the points to the monthly savings gained from the lower payment. The break-even point is reached when those monthly savings equal the upfront cost. If you expect to keep the loan long enough for the monthly savings to exceed the upfront payment, paying points saves money; if you won’t stay in the loan long enough, it may not be worth it.

Note that some fees labeled as points can be origination points, which are fees to obtain the loan and don’t lower the rate. Discount points specifically reduce the rate and are the type discussed here.