If you're shopping for a new home and mortgage, you're going to hear a lot about points. A "point" is 1% of the value of the mortgage loan. So, if your mortgage is $200,000, one point is $2,000. When someone takes out a mortgage, "points" are often involved. Typically, these are "origination" and "discount" points.
Origination points are charged for originating, or launching, your mortgage. You pay these points up front when you begin the mortgage. On the other hand, discount points are typically optional and serve to lower your interest rate (and thus your payments). The idea here is that if you cough up a little extra at the beginning, you can pay less over time. For lenders like Citigroup
Although it may appear that your interest rate is the one officially listed on your mortgage, that's not necessarily a reflection of the actual rate you'll have paid over the life of the loan. You should incorporate the effect of points into the rate and your total loan. For example, if your mortgage is for $200,000 and you pay a total of two points, then you're really paying $204,000 -- plus interest.
What to do
So when should you pay points, and when should you skip 'em? Well, at mtgprofessor.com, Jack Guttentag (who, coincidentally, was actually my mortgage professor in business school) has said,
It makes sense if you have the money and expect to have the mortgage for 3-4 years or longer. Paying points can be viewed as an investment that yields a return that rises the longer you stay in your house. The return consists of the saving in monthly payment resulting from the lower interest rate, plus the lower loan balance in the month the loan is paid in full. This return can be compared to the return on other investments available to you over a similar time horizon.
You can learn more about homebuying in our Home Center -- we've even got some good deals on mortgage rates for you there, as well as info on refinancing. In addition, drop by our Buying or Selling a Home discussion board. Our personal-finance calculator nook sports a calculator to help you figure out whether you should bother paying points.
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. JPMorgan Chase is an Income Investor recommendation. Try any one of our investing services free for 30 days. The Motley Fool is Fools writing for Fools.