Should You Pay Mortgage Points?
To pay or not to pay points.
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Should You Pay Mortgage Points?
To pay or not to pay points? That is the question for today’s episode.
Episode 16 was about how to choose between a fixed or an adjustable mortgage. This episode is about another important aspect of selecting the right mortgage: how to decide whether or not to pay points.
What is a Mortgage Point?
OK, so what exactly is a point? A point is simply lender jargon for a percent. One point is equal to one percent of the loan amount.
Now, here’s a tip. Lenders use the term “points” to mean two very different things: It can mean a fee, called origination points, that lenders or mortgage brokers may charge for the work of originating your loan. It can also mean discount points, which are points you can choose to pay upfront to lower your interest rate.
If a lender or mortgage broker wants to charge you origination points, ask if they can reduce this fee. Not all lenders and brokers charge origination points, and the fee is sometimes negotiable.
Most of the time, when you hear the word “point,” it refers to a discount point. When you pay discount points, you’re prepaying interest in exchange for a lower rate. Lenders call this “buying down the rate.” The more points you pay, the lower your rate.
Should You Pay Mortgage Points?
So is it worth it to pay discount points to lower your interest rate? The answer really depends on whether you have the cash in hand to afford to pay points upfront and on how long you plan to keep your loan. The longer you plan to keep your mortgage, the more it makes sense to pay points because you’ll reap the benefit of the lower interest rate over a longer period of time.
If you do have the cash available to afford to pay points, here’s a “quick and dirty” way to decide whether it’s worth it. You’ll want to compare the monthly payment with points to the monthly payment without points. What’s the difference in monthly payments? Next, calculate how many months you would need to keep the loan with points to recoup the additional upfront amount you paid in points. This is the “pay-back” period.
If the number of months is considerably shorter than the length of time you plan to keep your loan, paying points is likely going to be worth it for you. In contrast, if the payback period is longer than the length of time you’re planning on keeping the loan, paying points isn’t worth it.
For example, let’s say you plan to keep your loan for five years and the loan amount is $100,000. And let’s say, with the loan you’re considering, your choices are 6.5% with no points or 6.25% with one point. Your monthly payment with no points would be $632, but if you pay a point (that is, $1000) to lower the rate, your monthly payment would be reduced to $616, a savings of $16 a month.
Given the $16-a-month lower payment, how many months would it take to get your $1000 back? A little longer than 62 months (or about 5 years and 2 months). Since you don’t plan to keep the loan this long in this example, you’d actually come out ahead by not paying the upfront point.
Now this is just a “quick and dirty” way to get a rough idea of whether paying points is worth it. It doesn’t factor in the tax deductibility of mortgage interest. In most cases, discount points, because they’re prepaid interest, are tax deductible. It also doesn’t factor in the missed opportunity of how you might have otherwise invested the $1000.
I’ve included a link to a “points versus no points” calculator at the end of the transcript. The calculator lets you see how investing the money instead of paying points affects the decision.
And here’s one final pointer on points: When you’re shopping for a mortgage and different lenders quote you rates, ask them to quote you the rate at no points so you can make apples-to-apples comparisons. Beware! Sometimes a lender will quote you a rate that sounds too good to be true. Be sure to ask them if you have to pay points to get that rate and, if the answer is “yes,” ask them what the rate would be with no points.
Administrative
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Should I pay points to my lower rate? Click here for a calculator.
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