Deciding Whether or Not to Pay Points on a Mortgage

When a homebuyer pays for “points”, he or she is paying a portion of the loan’s interest up front. Points are paid for in a lump sum that will reduce the interest rate on a fixed mortgage. Each mortgage loan point costs the buyer 1 percent of the total mortgage amount. So, for a home with a price tag of \$100,000, one mortgage point would cost \$1000. The interest rate on a 30-year fixed mortgage is generally reduced by 0.125 percent for each discount point. The more points the buyer purchases, the lower their final mortgage rate will be. Most lenders offer up to three points.

In choosing whether or not buying mortgage points in beneficial, it is necessary to ask yourself a few questions:

Can you afford to pay for the points up front? Would it be better to save any extra cash for other expenses that a home purchase will undoubtedly necessitate?

How long do you plan to keep the home and this mortgage? Those in it for the long term could stand to gain more from lowering their interest rate.

One helpful tool to use when making this choice is a mortgage calculator. It will help you determine the amount of the monthly house payment at the interest rate you will lock into without buying points. Then, calculate the price with points. To see how much buying the points would save you, subtract the lower payment from the higher payment. Finally, divide the cost of the points by the monthly about that could be saved. That answer is also the number of months that you would need to keep the loan in order to reach the “break even” level on paying for points.

Here is an example:

• For a 30-year fixed rate loan of \$100,000 with a 6 percent interest rate, the monthly payment for the principal and interest would be \$599.55.
• Buying 3 mortgage points for a total cost of \$3000, would trim the interest rate down to 5.25 percent. That would lower the monthly payment to \$552.20 and save \$47.35 a month.
• The cost of the points (\$3,000) divided by the monthly savings (\$47.35) determines the length of the loan. So for this example: 3,000 divided by 47.35=63

So the break-even point would be 63 months or just over 5 years. If you plan to remain in the house for at least that long, then purchasing points might make sense.

Other things to consider when deciding if buying mortgage points is a smart move are:

• In some cases, the seller agrees to pay for the discount points. Discuss this with your lender to find out if the guidelines for your loan allow this. Typically, the seller would negotiate a higher price in return, however, you would have a little extra cash at closing.
• Another matter to take into account are that points for residential real estate may be tax deductible. Talk to a tax professional to see how this could affect your situation.