Point

Key Takeaways

• One point equals one percent of the loan amount, so points are always figured on what is borrowed and never on the sale price.
• Discount points are prepaid interest that buy a lower note rate; origination points are a charge for making the loan and buy no rate reduction.
• Points are paid in cash at closing, so a rate buydown raises the buyer's cash to close rather than the loan balance.
• Washington's Mortgage Broker Practices Act requires the amount of points to appear in the written disclosure a mortgage broker gives the borrower (RCW 19.146.030).

What It Means

A point is a lender fee equal to one percent of the loan amount, paid in cash at closing. On a $420,000 loan, a point costs $4,200. The base is the loan, not the purchase price, and that one distinction is where most exam questions about points are won or lost.

Points come in two kinds that look alike on a settlement statement. Discount Points are prepaid interest: the borrower pays money up front in exchange for a lower note rate, which lowers every payment for as long as the loan is held. An origination point is a charge for making the loan and buys no rate reduction at all. Both are quoted as a percentage of the loan and both come due at closing.

Because a discount point trades cash today for savings spread across years, it pays off only if the borrower keeps the loan long enough. Divide the up-front cost by the monthly saving to find the breakeven month; selling or refinancing before that month wastes the money. Points also compete with the Down Payment for the same funds, since both are owed on the same day.

How It Works in Washington

In Washington, the rule that reaches points most directly is a disclosure requirement. RCW 19.146.030, part of the Mortgage Broker Practices Act, requires a mortgage broker to give the borrower a full written disclosure containing an itemization and explanation of all fees and costs the borrower is required to pay, and the statute names what must appear, including the annual percentage rate, the finance charge, the amount financed, and the amount of points or prepaid interest. A borrower quoted a rate with two points should be able to find that charge stated in dollars on that disclosure.

The loan those points buy down is secured in Washington by a Deed Of Trust. RCW 61.24.020 provides that a deed conveying real property to a trustee in trust to secure the performance of an obligation of the grantor to the beneficiary may be foreclosed by trustee's sale, and directs the county auditor to record it as a mortgage with the grantor listed as mortgagor. Paying points changes the interest rate on the promissory note. It changes nothing about the security instrument or the trustee's power to sell on default, which is why points are a pricing question and not a title question.

Example

Priya is buying a Spokane condo for $525,000 and putting 20 percent down, which is $105,000, so her loan is $420,000. Her lender quotes 6.75 percent with no points, or 6.25 percent if she pays two discount points at closing. Two points on a $420,000 loan is $8,400.

Watch the base. One percent of the $525,000 price would be $5,250, so a student who charges points against the price overstates Priya's cost by $1,050 per point. Over a 30-year Amortization, principal and interest on $420,000 run $2,724.11 a month at 6.75 percent and $2,586.01 at 6.25 percent, a saving of $138.10. Dividing the $8,400 cost by that $138.10 saving gives about 61 months, so Priya breaks even a little past her fifth year and comes out ahead only if she keeps the loan longer than that. She also has to produce the $8,400 in cash on top of her $105,000 down payment. Our guide to what to expect at a Washington closing shows where charges like these land.

Common Mistakes and Exam Traps

• A point is one percent of the loan amount, not one percent of the sale price. On a $525,000 home with a $420,000 loan, a point is $4,200 and not $5,250.
• Discount points lower the interest rate. Origination points pay the lender for making the loan and lower nothing.
• Paying points does not reduce the loan balance and builds no equity. The borrower still owes the full principal after paying them.
• Points paid on a loan are not added to the property's tax basis. IRS Publication 551 excludes charges connected with getting a loan from basis, even though other closing costs are included.