With the number of home purchases on the rise due to the Federal Housing Tax Credit, many first time home buyers are getting a crash course in mortgage points from potential lending agencies. A mortgage point is a fee applied toward the financing of a home loan.

One point is equal to one percent of the amount of the loan, so the cost of one mortgage point if you are financing $80,000 would be $800. There are also two forms of mortgage points, those being discount points and origination points, and each serves a different purpose.

Discount Points

Discount points act as a tax deductible way to prepay interest up front in order for the buyer to lower their monthly mortgage payment. Buyers often have the option of deciding how many points they would like to buy, and the amount they choose is usually based off of how much they would like to lower their interest rate. The maximum number allowed for purchase is usually four.

Using the same example as above, if a buyer purchased four discount points at $800 each they would pay $3,200 toward interest at closing, thus lowering their monthly payment.

For most financing programs either the buyer or the seller can purchase the mortgage points, or an agreement can be made to split the payments. Not all loans allow buyers to purchase mortgage points, which is the case for FHA and VA guaranteed loans. In these cases only the seller is able to purchase the points.

Origination points are not as common as discount points, as they tend to benefit the lender rather than the borrower. An origination point acts as a fee charged by the lender to cover the costs associated with developing the loan. This would be in addition to the buyer's other closing costs, so generally it is in the borrower's best interest to try and find a loan that does not charge origination points. Unlike discount points, origination points are not tax deductible. 

If you are buying a starter home with the intention of only owning the house for a couple of years, obtaining mortgage points may not be in your best interest. Discount points will help to lower the amount of interest paid long term, but they will not be beneficial unless the buyer expects to retain ownership of the house for at least six years.

The longer the buyer finances the property under the loan, the more the money used to purchase the points will pay off. The buyer will also want to factor in other closing costs they will be required to pay before obtaining mortgage points, as this could affect the number of points they are willing or able to purchase.