What are Mortgage Points? Should I Pay Them?
First of all, what are points? Borrowers pay points to lenders when a loan is settled. A point represents 1% of the face value of the loan. If your mortgage is in the amount of $100,000, one point would cost you $1,000.
The purpose of points is to reduce the overall interest rate on the mortgage. The ratios can be different, depending on the market and the bank, but here is an example for a mortgage at 6.25%: if you pay one and one half points, you will reduce the home loan rate to 5.875%, if you pay 2 ? points, you would reduce the rate to 5.375%.
The main issue 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. Don?t be tempted by the idea of borrowing extra to have the money to pay for points; this doesn?t make any economic sense. In many instances, especially for young buyers with a starter home that they hope to move out of in a short time, one should not consider paying for points.
As a rule, points are a deposit on your interest rate that you will draw against over the life of the mortgage. Let?s say you?re thinking about paying 1.5 points to get a reduction in your home loan rate from 6.00% to 5.50%. You are paying some of your interest in advance, in effect.
There are many calculators on the internet that can help you calculate how much you can save in monthly mortgage payments by paying upfront points, based on the length of the loan or you can take the easy way out and contact a mortgage professional to do it for you.
For our hypothetical $100,000 mortgage, you would have to pay $1,500 in points to receive the interest rate decrease to 5.5%. Then it is a question of finding the breakeven point, by examining the mortgage payment differences between the two rates. For a $100,000 loan, the monthly payment is $599.55 for a 15 year mortgage. A $100,000 6%, thirty year mortgage will cost $567.79 per month.
The points paid will save you $31.76 a month, but you had to give your lender $1,500 in order to reap this savings. If you divide your investment of $1,500 by your savings of $31.76, you will see that it will be 47.23 months for you to recoup the investment. If you don?t plan on staying in this home for this length of time, you will not benefit from paying points.
However, after the 47.23 months have elapsed, each month payment is a savings. If, a very big if in today?s mobile society, you lived in your home for the full thirty years of the loan, and multiply the $31.76 per month savings over thirty years, you would save $9,933.58 over the entire term of the loan!
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