Points are prepaid interest. One point is equal to one percent of the loan amount. So, for a $100,000 loan with one point, either the buyer or the seller would pay $1,000. By prepaying the interest in the form of points, you lower the interest paid monthly and the monthly payment. This is also called an “interest rate buydown”. Sellers may offer to pay points in order to reduce the monthly payment for a buyer, allowing the buyer to afford more home.
Points should not be confused with origination fees, though the two are commonly confused even by mortgage and real estate professionals who may call a 1-percent origination fee a “point.” Origination fees do not reduce your payment or monthly interest, they are simply the fee paid to the lender to cover their costs (including profit) in making the loan. In the past, origination fees were more common and higher with mortgage brokers than with banks. In today’s loan market where banks are often acting in the same capacity as mortgage brokers rather than making loans they intend to hold for a full 30 years, origination fees can be just as high at banks.
One important reason to distinguish points from origination fees is the tax consequences. Since points are interest payments, they are subject to the home mortgage interest deduction - they can save the buyers money on their federal taxes if paid by the buyer. Origination fees are not deductible to the buyer. (Fees paid by the seller on behalf of the buyer may reduce the seller’s gain on the sale, though.) Of course, you should consult a tax professional to learn the full tax consequences.
