Many people don?t really know what ?points? are when it comes to discussing their mortgage. Borrowers pay points to a bank when a loan is closed. each point represents a percentage point of the whole loan value. If your home loan is for $100,000, one point would cost you $1,000.
The idea behind points is to reduce the overall interest rate on the mortgage. Points, tough, are used in different ways by different lenders, so that one point at one lender may reduce your loan by 3/8%, whereas at a different lender it may be worth ?%.
The main criteria for whether or not you should pay points is how long you think you will have the home loan, since paying the upfront cost, and moving out 2 months later makes no sense. If you need to borrow to pay the points, you will probably lose any advantage since you have to pay the additional interest. If this is a first home, and you are hoping to move up to a larger home in a few years when you start a family, paying points is probably not a good idea, and here is why.
As a rule, points are a deposit on your interest rate that you will draw against over the life of the loan. Paying 1.5 points to reduce your mortgage from 6% to 5.5% is an investment, but is it a smart one? It is rather like prepaying some of your mortgage interest bill.
You can figure 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. Then it is a question of finding the breakeven point, by looking at the mortgage payment differences between these two rates. The cost of a $100,000 15 year mortgage at 5.5% is $599.55 per month. For a 30 year maturity, it would be $567.79.
The lower rate mortgage is $31.76 a month lower, but you had to pay points to get this lower payment. Simply divide $1,500 by $31.76 and you will see that it will take 47.23 months for the payment to be fully amortized. If you don?t plan on living in your home for this length of time, you will not benefit from paying points.
However, once the 47.23 months have elapsed, each month payment is a savings. Let us now suppose (this doesn?t happen very often today) that you actually stayed in your home for the thirty years; you would save that $31.76 over the entire term of 30 years, a big savings of $9,933.58!
