Mortgage Points – To Pay or Not to Pay

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If you have never purchased a home before, you may wonder what kind of code is being spoken when you hear two people talking about paying points. In fact many a heated argument has flared up over the issue.

 Just Say No to Points

When it comes to the question of points there are always those who categorically refuse to pay them, and others who always pay points. A blanket refusal to pay points makes about as much sense as blindly paying them. Before you can make that decision you have to look at the circumstances surrounding your situation. If you’re refinancing your mortgage you need to take in account several factors:

  • Length of time you expect to keep the loan
  • How long it will take to recoup the cost of the points
  • Whether there is a prepayment penalty or not

Only after you crunch the numbers can you determine whether or not paying points makes financial sense.

 What are Points?

Points are the industry’s way of allowing borrowers the chance to buy down their interest rate when refinancing an existing home, or purchasing a new one. Points reflect a percentage of the entire loan amount. One point equates to one percent. If you’re borrowing $300,000 to buy a home, paying one point would be paying one percent of that 300 grand, or $3,000. You can either pay that 3 grand out of pocket, or you can wrap that up into the loan, so your new loan amount would be $303,000.

In return for paying that 1 point, your lender will drop your rate. With each point paid your rate will drop incrementally, and not necessarily a percent for each point paid. To find out just how much you can drop your interest rate by paying points, you’ll have to check your lenders buy down schedule. To lower your interest rate a full percent you might have to pay three points or $9,000 on a $300,000 loan. Now you’re probably thinking 9 grand is a lot of money; and you’re right it is. However, that $9,000 can save you far more than that over the life of your loan. Let’s take a look at the numbers.

 Black and White

In order to really tell if paying points will save you money you’re going to have to put it down on paper in black and white. What does that one percent you are getting off your interest rate really mean to you?

At a rate of 5 percent, you monthly payments on a $300,000 loan would be $1,610 a month. On that same loan, a rate of 4 percent would make your payment be $1,432 or a monthly savings of $178 a month. If you were to save $178 a month for 30 years your total savings would be a staggering $64,080. In other words, you would be paying $9,000 to save $64,080. If someone were to give me 64 grand every time I gave them 9 grand I’d never stop giving. In this scenario, paying points is a no brainer. So when would it not make sense to pay points?

 Short Term Loan

Generally, the primary reason for not paying points is going to be because the borrower is planning on selling the home or possibly moving in a few years. If you were to do that same refinance loan for $300,000 and move in 5 years, would it make sense to pay points? Let’s see. Over 60 months, or 5 years you will be saving $178 a month for paying points. That means over 5 years your saving would be $10,680. Not really a significant savings. In this case it would probably not make sense to pay that extra $9,000. Because it takes almost 5 years to recoup the cost of your points, staying anything more than 5 years in your home would probably make sense. After that first five years, everything after is savings.

 The Case of the Prepayment Penalty

So what if I have a prepayment penalty? Most prepay penalties last for 2 years. Some lenders put 3 or 5 year prepayment penalties on their loans but that’s not as common, especially among your top shelf lenders like Bank of America and Wells Fargo for example. In case you’re wondering, a pre pay penalty is a fee charged to the borrower if he sells or refinances his home within the pre pay period; usually 2 years. The pre pay is usually 6 months principle and interest. On that $300,000 loan, the pre pay would be $9,660 at the 5 percent rate. What does that mean?

It means that if you were to buy down your rate from 5 percent to 4 percent which costs you $9,000 if you move before 2 years you would end up paying the prepay of $9,660 plus the $9,000 you are paying to get that lower rate. In other words it doesn’t make sense to buy down your rate if you think you might move before 5 years has passed or before 2 years has passed if you have a prepay.

 Crunch the Numbers

When it comes to buying down your loan you have to look at the numbers before you can really tell if it makes sense. It’s easy to do. Just go online and Google free mortgage calculator and just input the loan amount and the interest rate. The calculator will spit out the monthly rate amortized over whatever period you choose. Input different rates to see whether it makes sense for you to pay points.

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