Points

Points are upfront fees paid at mortgage closing, where each point equals 1% of the loan amount. In their most common form — discount points — they function as prepaid interest that buys the borrower a lower interest rate for the life of the loan. For note investors, points are part of the original loan's cost structure and appear in the collateral file documents. While they do not directly change a note's secondary market value, they provide useful context about loan terms, borrower profile, and regulatory compliance.

How Discount Points Work

Discount points create a straightforward trade: pay more upfront, pay less each month. The borrower gives the lender a lump sum at closing in exchange for a permanent rate reduction.

• One point = 1% of the loan amount. On a $250,000 mortgage, one point costs $2,500.
• Rate reduction = Typically 0.125% to 0.25% per point, though this varies by lender and market conditions.
• Breakeven period = The number of months it takes for the monthly savings to recoup the upfront cost.

Here is a practical example:

If the borrower sells or refinances before hitting the breakeven point, the points were a losing proposition. This is why points make the most sense for borrowers who plan to hold the loan for many years.

Types of Points

Not all points are the same. The term is used in multiple contexts:

• Discount points — Prepaid interest to reduce the rate. This is what most people mean when they say "points." May be tax-deductible as mortgage interest.
• Origination fee points — Charged by the lender to cover processing costs. One origination point is 1% of the loan amount, but it does not reduce the rate. Not typically tax-deductible.
• Buydown points — Sometimes paid by a seller or builder to temporarily reduce the borrower's rate for the first one to three years (a 2-1 buydown, for example). These are not permanent rate reductions.

When reviewing loan documents, it is important to distinguish between these types because they have different implications for APR calculations, regulatory compliance, and tax treatment.

Points in the Collateral File

During due diligence, note investors encounter points in several documents:

• Closing Disclosure (or HUD-1) — Shows exact dollar amounts paid for discount points and origination fees in Section A (origination charges).
• Promissory note — The interest rate on the note reflects any point-driven rate reduction. The note itself does not usually reference points paid.
• Good Faith Estimate (for pre-2015 loans) — Itemizes estimated points alongside other closing costs.

The key thing to verify: the interest rate on the promissory note should be consistent with any points paid at closing. If the borrower paid two discount points but the note rate appears unusually high, that warrants further investigation into the loan's origination.

Why Points Matter to Note Investors

Points do not affect the note's market value after origination — a secondary market buyer is purchasing the remaining cash flow stream at the stated note rate, regardless of how that rate was achieved. However, points are relevant in several situations:

• Regulatory compliance — Total points and fees are capped under Qualified Mortgage (QM) rules at 3% of the loan amount for most loans. Loans exceeding this threshold may carry additional legal risk and potential assignee liability.
• Borrower behavior signals — A borrower who paid points likely planned to keep the loan long-term and was financially positioned to bring extra cash to closing. This can be a positive indicator when evaluating a performing note.
• Effective borrower cost — Understanding the total origination costs (points plus fees) helps reconstruct the borrower's day-one equity position and their original loan-to-value ratio on an all-in basis.
• Seller-financed notes — In seller financing, points are less standardized. Some seller-financed notes are created with no points at all, while others may include charges that do not align with conventional lending norms — a factor to evaluate during collateral review.