When closing on a mortgage, there are many different costs that the borrower must incur. One of these costs is mortgage “points,” and is essentially a fee that the borrower pays the lender in order to use their money. This is also known as a “cost of credit,” and is part of the investment return to the lender. Each “point” is equal to one percent of the loan amount and must be paid upon closing the loan. If your loan amount is for $100,000, then 1 point is equal to a payment of $1,000.

Points are related to the interest rate you will be paying on the loan. Usually, the more points you pay upon closing the loan, the lower your interest rate will be. Conversely, the fewer points you pay, the higher the rate. Most lenders in the United States will offer you a variety of combinations of points and rates in order to find the right loan for you. If you are short on cash when the loan or mortgage is finalized, then a combination with fewer points is probably the better solution. However, if you plan on having the loan for a long period of time and have available funds, then it would be in your best interest to pay for several points, as you will benefit in the long run with a lower interest rate.

Other issues must be considered, however. Are there better ways you could use the cash if you opt to pay for more points? If you opt for fewer points, are you sure you’ll have the loan for a short period of time? For example, with a $100,000 loan, you might be given two options: 3 points with a 6.5% rate, or 1 point and a 7% rate. In the first case, you’d pay $3,000 upfront (in the form of points), but only need to pay the 6.5% rate for the remainder of the loan (if it is a fixed-rate mortgage). In the latter case, you’d only need to pay $1,000 upfront, but you’d be tied to a higher 7% rate because of that. Consider your options carefully, paying special attention to your potential financial situation in the future, and how long you plan on having the loan. Think about your current cash situation, your various opportunity costs, and how much a higher interest rate could affect you in the future.