Choosing How Many Points You Want To Pay On Your Mortgage
Before you make such a decision, you have to understand exactly what points are
. Points are fees paid to the lender at the closing of the mortgage. One point is 1% of the loan. If, for example, you pay one point on a $100,000 mortgage, you will pay $1,000 at the settlement.
The idea behind points is to reduce the overall interest rate on the mortgage. There are different ways of calculating the benefit of a point, depending on the lender, but an example would be to pay 1.5 points to reduce your loan from the posted rate of 6.25% to 5.875%, or to 5.375% if you paid 2 points.
The longer you will live in the home, the more sense it makes to pay points; you also have to decide if you can afford to pay the points. If you need to borrow to pay the points, you will probably lose any advantage since you have to pay the additional interest. First time home buyers usually will not find it advantageous to pay points, since many do not stay in this home for long.
You have to look upon points that you pay as an investment in your loan. Paying 1.5 points to reduce your mortgage from 6% to 5.5% is an investment, but is it a smart one? It is rather like prepaying part of your mortgage interest bill.
You can figure whether or not it makes sense for you to pay points, depending on how long you will be in your home; use one of the many calculators on the internet or ask a mortgage consultant to do it for you, free of cost.
For our hypothetical $100,000 loan, you would have to pay $1,500 in points to receive the interest rate decrease to 5.5%. Then it is a matter of finding the breakeven point, by examining the mortgage payment differences between the two rates. A $100,000, 5.5% fifteen year mortgage will cost $599.55 per month. A $100,000 6%, thirty year mortgage will have a payment of $567.79 per month.
Since the reduced rate saves $31.76 per month, you have to now compare that to how much the upfront payment in points cost you. All you have to do is divide $1,500 by $31.76 and you will see that it will take 47.23 months for the points to be fully amortized. That makes the decision simple; if you do not plan on being in your home a minimum of 47.23 months, the points do not gain you any advantage.
Once you have amortized that first $1,500 investment, however, you will have a clear savings of $31.76 per month. If you, unlike most homeowners today, stay in your home for the full thirty years, you would have saved $31.76 over those years, which is a total savings of $9,933.58.
by: Dale P. Issa
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