Mortgage Refinancing - Points—What are They and What Do They Cost?

Lower your rate with points. A point, defined as charges paid to the lender, usually paid at closing, equals one percent of the loan amount. If you have a $250,000 house, one point is $2,500. If you're planning to refinance your home at 6%, for example, you may want to consider making your interest rate even lower by paying one point. Reducing the interest rate by paying these points is called "buying down" the rate because you're paying interest up front. Points are also referred to as "prepaid interest". In some instances, a lender may finance the points so you will not have to pay them up front. If you do have to pay out of pocket for the points at closing, you would just add it to the other closing fees for the loan.

Before you refinance, compare different lender rates and points. Usually, a lower rate indicates more points. For example: You want to refinance your home with a $100,000 loan. Each “point” would cost you 1% of $100,000 or $1,000 but would reduce your loan’s interest rate by .125%. The lender might offer you an 8.0% loan with zero points, a 7.875% loan with one point or a 7.75% loan with 2 points.

When to Use Points. If you plan to move within two years of refinancing, paying points might not be a good idea. It takes about 5 to 7 years to recover the cost of points paid at closing. Example: You have a 30-year fixed mortgage loan for $100,000 with an interest rate of 6.75% with one point and a monthly payment of $645. If you did not have the point, the interest rate would be 7% and the monthly payment is $661.17. The point saves you $16.17 per month. In five years, you will have recouped the point paid to get the lower rate. Because you will continue to pay lower payments each month after your money is recovered you will benefit from lower monthly payments. But if you move after two years you will not recover your costs.

Points are paid at closing. In some cases, lenders will allow borrowers to finance the points over the term of the loan. Lenders sometimes use points to make their interest rates appear lower. Be aware that a lower interest rate offered by a lender may translate into higher points requirements.

Note that if you choose to pay points, generally these are tax deductible over the life of the loan unlike the total deduction you may take when you first purchase the home. So if you refinance with a 30-year mortgage and pay $1,500 in points, you likely will be required to deduct 1/30 of $1,500 or ($50) each year you own the home, rather than deducting all $1,500 in the year you do the refinance.