First of all, what are points? Borrowers pay points to lenders when a loan is settled. Each point=1% of the mortgage. In other words, if you are required to pay 1 point, this means you have to pay $1,000 on a $100,000 loan.
The idea behind points is to lower the overall interest rate on the mortgage. The ratios change, depending on the market and the bank, but let’s take an example for a mortgage at 6.25%: If you pay one and one half points, you will lower the mortgage rate to 5.875%, if you pay 2 points, you would reduce the rate to 5.375%.
The longer you plan to live in the home, the more attractive it is to pay points; you also have to decide whether you can afford to pay the points. You should not even consider borrowing to pay points since this will just add to the cost of the loan. 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. Perhaps you decide to pay 1.5 points to get a reduction from 6% to 5.5%, that’s the investment you make. It is rather like prepaying some of your mortgage interest bill.
It can be calculated whether or not it makes sense for you to pay points, depending on the length of time you will be in your home; use one of the many calculators on the internet or ask a mortgage consultant to do it for you, free of cost.
Let’s discuss our $100,000 loan that could be reduced to 5.5% if $1,500 were put down in points. What is the breakeven point in this scenario, based on the different rates? The monthly payment for a 15 year 5.5% loan is 599.55 a month. A $100,000 6%, thirty year mortgage will have a payment of $567.79 per month.
Since the reduced rate saves $31.76 per month, you have to now compare that to what the upfront payment in points cost you. All you have to do is divide $1,500 by $31.76 and you will realize that it will take 47.23 months for the points to be fully amortized. In other words, if you don’t plan on being in the home for about 4 years, you get nothing by paying the points.
Once you have amortized that initial $1,500 investment, however, you will have a clear savings of $31.76 per month. If you, unlike 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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