Decoding the Mysterious Mortgage Points Game

Does it make sense to pay "points" upfront to lower your interest rate?

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My husband and I are in the process of buying our first house. The first step, our real estate agent told us, was to get pre-approved for a mortgage. That way, once we find a house that we like and want to make an offer, the sellers will take us seriously.

So we called a lender, gave her all of our personal information, from the debts we owe (student loans) to our incomes, and a few hours later she E-mailed us a big packet of information containing our pre-approval. It all seemed very efficient -- except I could hardly understand a word of the documents. First of all, there were two different sets of them, one with points and one without points. What were points? Did we want them or not? And why would the mortgage industry invent such a confusing concept -- or why did we let them?

I immediately twittered about my frustration. Chris Jones, a real estate expert at the Chris Jones Group in Lehi, Utah, was listening, and tried to explain the points system on his blog. He started with the definition: One "point" equals one percent of the loan amount. He continues with an example:

Jane wants to get a $200,000 loan. ...The rate where the broker makes nothing from the lender and pays nothing to the lender is called par. ...Usually, a broker will quote you a rate higher than par, so he can make some money on the margin.

In our example, the wholesale rate is 4.75 percent. The lender quotes Jane 5 percent as the rate for her loan. If Jane wants a better rate, say, 4.5 percent, it will cost .248 (times the loan amount) – this is called paying points. If she wants 5.5 percent, Jane should get back a chunk of money to defray her loan costs.

In other words, Jane should decide what her rate is, not her broker. The lower she wants it, the more it will cost. The higher she can stand it, the less it will cost, to the point that at some rates, the rate will pay her, and eliminate some of the cost of the loan.

That's as good an explanation as any other I've seen. Now, if someone could just tell me why I have to pay over $10,000 in a "recordation tax"...