As with everything else, there are good points and bad points. Bad points are the ones you pay; good points are the ones someone else pays. They are charged by lending institutions as extra upfront, one-time lump-sum interest, when a new loan is placed.
Each point is 1 percent of a new loan being placed. If you buy a home in Kansas City for $150,000 and borrow $120,000, one point would equal $1,200 (not $1,500). Two points would be $2,400. The term is sometimes used interchangeably with percent, as in “You’ll have a two-point cap…”, which means you’d have a 2-percent cap.
When Are Points Paid?
Points are usually paid at final settlement when the loan is actually made or, occasionally, at the time of mortgage application (in which case, find out whether they are refundable if the loan does not go through).
Sometimes you can pay extra points in return for special favors. A lock-in guarantees that you’ll receive the rate in effect when you apply for the loan, no matter what has happened to rates in the meantime (but what if rates go down before your closing?) Or you may be charged extra for an extension if you don’t close within a given period after the bank commits to making the loan.
When rates are fluctuating rapidly, some borrowers have been known to make mortgage application at two different lenders: one with the rate locked in, and one without. For whichever loan isn’t eventually chosen, the wheeler-dealer will forfeit an application fee, usually several hundred dollars, to cover at least an appraisal and credit report. If wide-spread, the practice would pose a great nuisance to lenders, but it could give the applicant a chance to choose the more favorable loan at the last minute.
Who Pays the Points?
Points may be paid by either buyer or seller, depending on their agreement. Points paid by you as the buyer of your own residence are income-tax deductible as interest in the year they are paid. Points you pay to purchase income property must be amortized (deducted bit by bit over the years) along with the other costs of placing an investor’s loan.
Points paid by the seller are one of the expenses of selling, and reduce the seller’s capital gain on the sale. The buyer, however, is allowed to take points paid by either party as an income tax deduction for interest expense for that year.
Ask T. J. Lamb, T.J. Lamb Real Estate, about Kansas City real estate.
This Home Buying Tip was excerpted from:
The Home Buyer’s Kit, Third Edition , by Edith Lank, Dearborn Financial Publishing , Inc., 1994.