“Mortgage points”, also known as loan origination points, mortgage loan points or mortgage discount points, are fairly simply to understand. When it comes down to it, a mortgage point is just a fancy way of saying a percentage point of the loan amount.
Essentially, when a mortgage broker or mortgage lender says they’re charging you one point, they simply mean 1% of your loan amount. So if your loan amount is $400,000, one mortgage point would be equal to $4,000. If they charge two points, the cost would be $8,000. And so on.
A mortgage point can vary greatly based on the loan amount, so not all mortgage points are created equal investors.
Types of Mortgage Points
A mortgage broker or bank may charge mortgage points simply for doing the loan, known as the loan origination fee. This fee may be in addition to other closing costs, or a lump fee that covers all your closing costs and their commission.
Alternatively, you may be charged mortgage discount points, which are a form of pre-paid interest in exchange for a lower interest rate. These types of mortgage points are tax deductible.
If you aren’t being charged mortgage points (no cost refi), it doesn’t necessarily mean you’re getting a better deal. All it means is that the mortgage broker or lender is charging you on the back-end of the deal. There is no free lunch.
In other words, the lender is paying the broker a certain percent for a rate higher than what the par rate, or market rate would be.
So if your particular loan scenario had a par rate of say 6%, but the mortgage broker could earn two points on the “back” if he/she convinced you to take a rate of 6.75%, that would be the broker’s yield-spread-premium (YSP), or commission.
This is a common way for a broker to earn a commission without charging the borrower directly. However, the borrower still pays the price by taking a higher mortgage rate than necessary, which equates to a lot more interest paid throughout the life of the loan.