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.
This question comes up a lot when I am working with my clients and we are discussing their loans. In this Blog I will help explain the difference between interest rate and APR (Annual Percentage Rate). To break it down, the interest rate is the percentage you pay on your loan amount financed. Although APR is quoted as an interest rate it is actually a way for borrowers to compare fees associated with the mortgage loan. Two identical loans with the same interest rate may have different APR’s. That is because of the fees involved with that loan. All things being equal, the higher the APR the higher the fees involved. Below I will explain in greater detail because a higher APR does not necessarily mean the loan is a better fit for your situation. As with everything in life there are tradeoffs.
Let’s start with some definitions:
What is the interest rate?The interest rate is the percentage of the loan amount that is charged for borrowing money. We can consider this the base fee. It is very important when comparing loan quotes since it directly affects monthly payments.
What is the APR (Annual Percentage Rate)?The APR is a little more complex and is comprised of two factors: it includes your actual interest rate and any additional costs. Additional costs might include things like prepaid interest, private mortgage insurance or closing fees. Your APR represents the total cost of credit on a yearly basis after all charges are taken into consideration. It is typically higher than your actual interest rate because it includes these additional items and assumes you will keep the loan to for the full term.
How APR is calculated?
To calculate the APR, the lender fees (fees required to finance the loan) are incorporated into the interest rate. This is done by amortizing the fees out over the life of the loan as if they were additional payments, and then calculating a new rate.
Limitations of APRAs useful as the APR can be, it has its limitations. APR spreads the fees paid upfront over the life of the loan. So the comparison of APR is only accurate if you plan to keep the mortgage for the entire length of the loan. Since most borrowers do not keep their loan for the full period (they typically refinance or move), the APR can make some loans look artificially better. In the example above, if you only kept the loan for 3 years, the second loan would be much more expensive even though it has a lower APR. This is because the $6,000 in fees is paid upfront whereas the higher interest rate in the first loan is amortized over the life of the loan.
The other problem with APR calculations is that different lenders may include different fees in their APR calculations for various loan programs. Remember to always ask your lender what is included and not included in your APR.
Most people look for no closing cost mortgage refinancing when interest rates are sliding and they want to take advantage of a lower rate without paying any up-front costs or rolling them into the new loan. Although new home purchasers can also find no or low closing cost mortgages you will find they are far more common in the refinance market.
Unfortunately, a no closing cost mortgage is never cheaper over the long term. Instead of paying fees up front or rolling them into the new loan the interest rate is typically .5 to .75 percent higher to cover the lender's costs and any third-party fees the lenders promises you aren't paying. The lender isn't giving anything away for free. This does not mean that a no closing cost loan is not right for you or your situation it depends on a many things.
No cost mortgages come in three flavors:
1. No points, but you pay lender fees and third-party fees
2. Zero lender fees, but you pay third-party fees
3. No cash up-front, but all the fees and costs are bundled into the loan's interest rate.
A true no closing cost mortgage would have the same interest rate as other loans and no payments to the lender or third parties. Understandably, these loans are nearly impossible to find.
Is No Closing Cost Mortgage Refinancing Right for Me?
This type of mortgage is best for people who plan to sell or refinance in a few years. If interest rates are steadily falling they can allow you to move from no cost refinance to no cost refinance without spending a dime on closing costs. If you want to stay in your home and never refinance again, then the higher interest rate will cost you more over the life of the loan.
For people who plan to stay in their homes for more than five years and don't plan to refinance again, the best bet is either pay up front or roll in the closing costs and get a lower interest rate. It doesn't seem like a lot, but the difference between 5% and 5.5% can really add up. On a $200,000 loan paid over 30 years that amounts to over $22,000 more in interest.
Where Can I Get a No-Cost Mortgage?
My company, 360 Lending Group, offers these types of loans as well as other more common types and will also take the time to educate you in all aspects of the loan process. This includes giving you all options so that you can make an educated decision on what loan product best suits your individual needs. Everybody is different and no one loan type is an exact fit for everybody.
No closing cost mortgage refinancing is a popular way to take advantage of falling interest rates. Just be sure to refinance to a lower rate and pay the closing costs before that additional interest really starts to add up.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.