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Understanding Points

Points are up-front interest, and points cost you money. Lenders charge points as a way of being paid for the work and expense of processing and approving your mortgage.

Lenders quote points as a percentage of the mortgage amount and require you to pay them at the time that you close on your home purchase and begin the lengthy process of repaying your loan. One point is equal to 1 percent of the amount that you're borrowing. For example, if a lender says that the loan being proposed to you has two points, that simply means that you must pay 2 percent of the loan amount as points. On a $120,000 loan, for example, two points cost you $2,400.

The interest rate on a fixed-rate loan has an inverse relationship to that loan's points. When you are able to (or desire to) pay more points on a mortgage, the lender should reduce the ongoing interest rate. This reduction may be beneficial to you if you have the cash to pay more points and want to lower the interest rate that you'll pay year after year. If you expect to hold onto the home and mortgage for many years, the lower the interest rate, the better.

Take a look at a couple specific mortgage options to understand the points/interest-rate trade-off.

When you buy a home, the points are tax-deductible -- you get to claim them as an itemized expense on Schedule A of your IRS Form 1040. When you refinance, in contrast, the points must be spread out for tax purposes and deducted over the life of the new loan.