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A generic term for a percentage of the principal conventional loan amount; a rate adjustment factor. A lender often charges a borrower some service charge points for making the loan. Each point is equal to 1 percent of the loan amount. In the initial stages of a loan application, the lender often does not know what loan amount will be approved, so he or she cannot state the finance charge in dollars and cents. Thus, it is convenient to state the charge as a set percentage of the loan amount, such as five points. Points are sometimes justified to cover lender expenses in originating the loan and to offset any losses when the mortgage is sold in the secondary mortgage market. Points can be used to increase the lender’s yield or to “buy down” the rate. In conventional financing, the points may be paid by the buyer or the seller.

The term points takes on numerous meanings in everyday practice and is a common source of confusion. Although used interchangeably, the terms points and discount charges are not synonymous. A point is technically a unit of measure. It measures not only the amount of “discount” but also other costs such as mortgage insurance premiums and origination fees. The borrower should insist on each cost item being properly identified.
The sales agreement should address the issue of who is paying points. The seller should be aware that if the seller pays points, the seller may have to pay more than originally anticipated due to such variables as an appraisal at a value lower than the seller originally thought; property repairs, as required per FHA, calling for building permit fees and other costs; and market changes that may cause a higher point structure.

Points are a onetime charge paid for the use of money. Deductibility for federal tax law varies. Points paid as compensation for the use of borrowed money qualify as interest for tax purposes rather than as payment for the lender’s services. These points are similar to a prepayment of interest and are to be treated as paid over the term of the loan for purposes of the prepaid interest rule. This also applies to charges that are similar to points, such as a loan processing fee or a premium charge. Note, however, that discount charges paid by the seller for an FHA loan are not interest and therefore are not deductible.
Homeowners who have refinanced existing loans solely to get a lower interest rate cannot fully deduct the points charged in connection with paying off their loans. The points must be amortized over the term of the loan.
Under federal truth-in-lending laws, the borrower’s payment of points must be reflected in the annual percentage rate and fully disclosed to the consumer.