Are Paying Points Worth It?

What are Mortgage Points?

“Mortgage points”, also known as mortgage origination or discount points. A point is just a fancy way of saying a percentage of the loan amount. Basically, when lender says they’re charging you one point, they simply mean 1% of your loan amount.

Example: If your loan amount is $400,000, one point would be equal to $4,000. If they charge two points, the cost would be $8,000. And so on.
home loan points

Types of Mortgage Points?

Origination points are used to pay for the costs of obtaining the loan. They are much less popular than discount points, as they do not provide borrowers with any valuable benefits. Borrowers are therefore better off trying to get a loan that does not require them to acquire these kinds of points.

Discount points refer to an amount of money paid to a lender to obtain a loan at a specific interest rate. These points are like pre-paid interest on a loan that a borrower takes out for a new home.

 

Premium points refer to an amount of money credited to the borrower from the lender in relations to a specific interest rate. This works the opposite of Discount points. This credit may be used to reduce closing cost. 

Are Mortgage Points Worth It?

The decision to pay points depends on a couple key considerations. (1) The length of time one plans to live in the house (2) If you have the cash in hand to afford the points. A mortgagor who plans to live in the house for many years would benefit from paying discount points because they will lower the interest rates for the long term. Another important feature of mortgage points is that they are tax deductible.

Here is a quick way to decide if paying points is worth it. First, you want to compare the interest rate with points to the interest rates without points. What is the difference? Next, you need to calculated your interest savings per year. What does this equal? Then, you need to calculate how many months you would need to keep the loan with points to recoup the upfront amount you paid in points. This is known as the “break even point” or “pay-back period”. If the number of months is considerably shorter than the length of time you plan to keep your home (loan), paying points is likely going to be worth it.

For example, let’s say you plan to keep your loan for five years and the loan amount is $200,000. You are considering a mortgage with a rate of 5.5% with no points vs 5.125% with one point. The difference in the interest rate is 0.375%, which equals a savings of $750 per year in interest. It would take you 2.6 years to recoup the cost of the point. Since you are on a five year plan in this example you would have saved $1,800 after recouping the upfront cost (point) with in the five years.

5.5% (rate) – 5.125% (rate) = 0.375%
$200,000  (loan amount) X 0.375% = $750 (savings per year)
$2,000 (cost of the point) divide by $750 = 2.6 (years to recoup the cost of the point)
$750 X  2.4 (years remaining after you recoup the cost in your 5 year plan) = $1,800
$750 X 7.4 (years remaining after you recoup the cost if you are on a 10 year plan) = $5,550 

In addition you develop $40 in cash flow per month. Your monthly P&I payment with no points is $1,634 but if you pay a point ($2,000) to lower your rate, your monthly P&I payment of would be reduced to $1,594. Difference of $40.

Keep in mind, this does not factor in the tax deduction you may qualify for. 


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