If you don’t understand the concept of points, you have come to the right place. Borrowers pay points to lenders when a loan is settled. One point is 1% of the loan. A $100,000 requires a $1,000 payment for one point.
The idea behind points is to reduce the overall interest rate on the mortgage. The ratios can be different, depending on the market and the lender, but here is an example for a mortgage at 6.25%: If you pay one and one half points, you will reduce the mortgage rate to 5.875%, if you pay 2 points, you would reduce the rate to 5.375%.
The main thing to consider when you are deciding upon paying points is how long you plan on living in your home, and whether or not you can afford the points upfront. If you have to borrow to pay the points, you will probably lose any advantage since you have to pay the additional interest. First time home buyers usually will not find it advantageous to pay points, since many do not stay in this home for long.
Points need to be viewed as an investment in the mortgage. Paying 1.5 points to reduce your mortgage from 6% to 5.5% is an investment, but is it a smart one? It is a bit like prepaying part of your mortgage interest bill.
Using any one of the mortgage point calculators on the internet, or by consulting with a mortgage consultant, you can calculate how much you will save in monthly payments on your mortgage, based on the number of years you will hold the loan.
For our hypothetical $100,000 loan, you would have to pay $1,500 in points to receive the interest rate reduction to 5.5%. Then it is a question of finding the breakeven point, by examining the mortgage payment differences between these two rates. A $100,000, 5.5% fifteen year mortgage will cost $599.55 per month. The cost of a $100,000, 30 year loan at 6% is $567.79 a month.
This is a clear savings of $31.76 per month, but remember you had to pay $1,500 to get this savings. $1,500 divided by $31.76 is 47.23 months, or almost four years. If you don’t plan on living in this home for this length of time, you will not have any advantage from paying points.
However, after the 47.23 months have elapsed, each month payment is a savings. If you, contrary to most homeowners today, remain in your home for the complete thirty years, you would have saved $31.76 over those years, which is a total savings of $9,933.58.
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