Should you Pay Points to Lower your Interest Rate?

Applying for a mortgage can seem like a daunting task if you aren’t familiar with some of the terms. For example, not only is the term “points” confusing for consumers, it can have different meanings among lenders.

In general, each “point” equals 1% of your loan amount. They are paid at settlement along with other closing costs such as a credit report, property appraisal, lender fees, and title-related expenses.

Points are commonly known as “Discount Points” when they represent a fee paid to the lender in return for a discounted interest rate. In other words, you are pre-paying interest up front in exchange for a reduced interest rate, which results in lower monthly mortgage payments.

On a fixed rate loan, the discounted rate will apply for the life of the loan; however, on an adjustable rate mortgage, or ARM, the reduction only impacts the initial loan term (and possibly the lifetime rate cap). So for a 5/1 ARM, the discount would only apply to the first five years before the rate could start to fluctuate.

Be sure to read our blog posts Choosing the Right Mortgage-Part 1 and Part 2 if you want to learn more about different home financing programs.

Lenders may also charge another type of point called an “Origination Fee.” In many cases, this represents the cost of obtaining a loan from that lender and may not result in a lower interest rate. Make sure you ask which type of points your lender charges for each loan program they offer.

So how do you know if buying points is a wise investment decision? Here are several important questions to ask yourself.

How long do you plan on owning your new home?

The longer you own, the more you could benefit from buying points. The interest saved over the years can be exponential. If you plan on selling right away or refinancing in the next few years, then paying points may not be the best option.

What kind of mortgage program are you considering?

Buying points to lower your rate may be a better option if you’re getting a fixed rate mortgage since the rate is lower for the entire loan term. With an ARM, the lower interest rate only applies to the initial term.

When is the breakeven point?

This is the amount of time it takes to recoup the upfront cost through lower monthly payments. See some examples below.

Do I have enough money?

Make sure you have enough funds available for your down payment, closing costs and other expenses before you decide if paying points is a good option.

Are there tax benefits?

Contact a tax professional to see how points could affect your individual situation.

 

So now that you know that each point is equal to 1% of your mortgage amount, let’s review how to calculate your potential savings.

In this example, we’ll use a 30 Yr. Fixed Rate and $300,000 loan amount. We’ll also assume each Discount Point lowers the interest rate by about ¼%. Keep in mind the actual rate discount will vary based on the loan program, current market conditions and other factors.

 

 

0 Points

1 Point

2 Points

Cost of Discount Points

$0

$3,000

$6,000

Interest Rate

3.75%

3.5%

3.25%

Monthly Mortgage Payment

$1,389

$1,347

$1,306

Monthly Savings

(Vs. 0 Points)

$0

$42

$83

Break-even from

 Payment Savings

N/A

71 months

72 months

Total Payment Savings

Over 30 Years

$0

$15,120

$29,880

It is important to note that these figures are for illustration only. Your interest rate, and the potential reduction available by paying points, will be based on your individual financing situation. There can also be wide variations in rates and loan options between lenders, so remember to do your homework and ask the right questions.

Please contact TBI Mortgage at 1-800-647-9735 if you would like to speak to a Mortgage Loan Specialist about your home financing options.

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