Points, also known as Discount Points, are a source of confusion for many home loan borrowers. When shopping for a loan, your clients have many options with respect to paying points.

A point is calculated as a percentage of the loan amount. For example, 1 point charged for a $ 100,000.00 loan would be $ 1000.00, and ½ point for the same loan would be $ 500.00.

Although "points" are part of the closing costs, they are not considered loan fees. They are an optional feature of the loan, which enable the borrower to buy the interest rate up or down. Interest rates are generally presented in increments of eighths.

The table below shows how different interest rates and points are typically shown. This example is also for a $ 100,000.00 loan amount. To get a loan with a rate of 6.00%, the borrower would not pay any points; however, to get a rate of 5.75%, 1.00 point ($ 1000.00) would be required.

When considering whether or not to pay points, most borrowers use the Break Even Analysis method. By paying points and obtaining a lower rate, your client will have a lower payment. It's up to your client to decide whether the monthly savings is worth the up front cost of the points. In the same example above, a $ 100,000.00 loan at 6.00% for 30 years has a monthly payment of $ 600.00. If your client pays 1.00 point ($ 1000.00), his/her rate would be 5.75% and the monthly payment would be $ 584.00. This represents a monthly savings of $ 16.00. So, in effect, your client would have paid $ 1000.00 up front to save $ 16.00 per month. At this rate, it would take just over 62 months (over 5 years) to recoup his/her investment or "break even".

Using the Break Even Analysis, take the following into consideration when helping your clients decide how many points to pay:

Your clients should pay zero or close to zero points if:

• Clients plan to stay in their home for less than 3 - 4 years
• Clients think they will refinance their loan within the next few years
• Clients are applying for an adjustable rate mortgage

Your clients should consider paying 1 or more points if:

• Clients plan to stay in their home for more that 5 years
• Clients plan to keep their property as an investment after they move
• Clients don't plan on refinancing in the near future

Tax deductibility is another factor to consider. For a loan to purchase a home, the points paid can typically be considered tax deductible in the year they are paid; however, with a refinance loan, the points paid can only be deducted over the term of the loan. Always refer recommend that your clients consult their tax adviser for specific tax rules.

Another important consideration is how to pay for the points. Although paying points will reduce your clients’ monthly payment, it may not always be their best option to pay them. Homebuyers are often strapped for cash and the money that would be allotted for points may be better used for furniture, new carpet or window coverings, especially if the alternative was to use a credit card. On a refinance transaction, the points can usually be included in the loan amount, rather than being paid out of pocket.