May 9th, 2009 1:13 PM by Don Groff, Mortgage Broker
By Don Groff
It depends. Whether or not it makes financial sense to pay points typically depends on how long you are going to keep your loan. When you pay a point, you are paying money upfront to lower your interest rate. A lower interest rate means that you will have a lower monthly payment (because the interest portion of your monthly payment will be lower), saving you money each month over the life of the loan.
This is usually a good financial deal if you plan to keep your loan for the full period. The amount you save each month over the life of the loan is much higher than the original price you paid for the point. However, most people only stay in their home for a couple of years or refinance before they pay off their loan. If you move or refinance before you have recouped the money you paid for the point, you will be losing money. So what you want to do is calculate how long it will take to recover the cost of a point and then decide whether or not you think you will still have the loan after that amount of time.
Let’s look at an example.
Scenario: $250,000 30-year fixed loan with $2,000 in fees. Option 1 is 5% with no points, and option 2 is 4.75% with one point (the point costs $2,500, or 1% of the loan, and is added to the fees).
Option 1 Option 2 Difference
Rate 5.00% 4.75%
Points 0 1
Fees $2,000 $4,500 ($2,500)
Monthly Payment $1,342.05 $1,304.12 $37.93
Total Paid $483,138 $469,483 $13,665
Total Interest $233,138 $219,483 $13,655
So you can see that with an upfront payment of $2,500 for the point, you will save $37.93 per month, which equals a total savings of $11,155 ($13,655-$2,500) over the life of the loan! That is a big discount.
In scenario 1, you will save $2,500 because you will not pay the point. In scenario 2, you will save $37.93 each month as a result of the lower interest rate. The total savings will continue to grow each month over the life of the loan. You will notice that option 1 is better if you have the loan for 66 months or less (because you save the $2,500 by not paying the point). However, if you have the loan for more than 66 months, option 2 is better since you will recoup the cost of the point and reap additional savings each month afterwards.
An easy way to calculate your breakeven point is to divide the cost of the point by the amount you will save each month (monthly payment 1 – monthly payment 2). This is the number of months it will take to break even. In this case it is $2,500/$37.93 = 66 months.
Don Groff has over 8 years of experience in the mortgage lending and real estate fields. His key areas of expertise are in residential mortgage lending and loan structuring to best suit his client’s needs and objectives.