What is Closing Points
Closing points are a fee paid to a mortgage lender or broker in exchange for a discount on the interest rate charged for a mortgage loan. Each closing point equals one percent of the total amount of the loan. Closing points are paid at the time of the closing the mortgage transaction. Closing points are also known as discount points or mortgage points. Closing points are not origination points, which are a fee paid to cover the costs of writing the mortgage loan.
BREAKING DOWN Closing Points
Closing points, or discount points, are a tradeoff of cash paid at closing in exchange for a lower interest rate for a mortgage. They are like a form of prepaid interest, in that buyers are paying up front to receive a lower interest rate over the term of the loan.
In some cases, closing or discount points are requirements as a condition to approving a loan. Because the lower interest will reduce the monthly payments, a borrower may qualify for the loan. These points are usually tax deductible for the borrower on Schedule A under the mortgage interest section. Points paid on a property purchase are entirely deductible in the year of purchase, while points spent on a mortgage refinancing loan require prorating over the life of the loan. This difference gives closing points greater financial value to the borrower than just the amount of money saved in lower interest amounts of monthly payments.
There is no constant direct correlation between the number of points paid at closing and the discount on the interest rate.
Benefits and Risks of Paying Closing Points
Paying closing points can allow a borrower to significantly lower the amount of interest they pay on the mortgage. They will have a smaller monthly payment as well as spending less in interest over the life of the loan, but there are risks in using closing points.
If the borrower should sell the home and pays off the mortgage before the difference in the interest paid and the cost of points reaches equilibrium, they may lose money. Paying closing points will also significantly increases the amount the borrower has to pay to close on the mortgage, so buyers who need to save money on the closing costs should not buy closing points.
For example, if the mortgage amount is $200,000 and the interest rate is 6 percent, the monthly payment is $1,482 per month. The lender offers one percent off the interest rate for paying three closing points ($6,000), so at a 5 percent interest rate, the mortgage payment would be $1,357 per month. The difference is $125 per month. When extended for the 48 payments, the saving is $6,000, the amount paid in closing points. In this case, the borrower must keep the home for more than four years for it to make financial sense to pay the closing points.