If you’re looking to purchase a home, you’re probably considering a few different loan options including those with points. Should you pay points on a mortgage? There are several factors to consider before deciding.
What Are Points?
Points are pre-paid interest that allow you to buy down an interest rate. For example, a lender may offer a 0.5% reduction in interest rate for paying 1 point. Each point represents a percentage of the loan amount. So, on a $400,000 loan, 1 point would be $4,000. On a fixed rate loan, paying points up-front will lock in the lower interest rate for the life of the loan.
Why Points Are Appealing
A lower interest rate, and therefore lower monthly mortgage payment, is always appealing to home buyers. Let’s assume that the lower interest rate saves $117 per month. That’s $1,404 per year, and even better, $42,120 over the life of a 30 year loan. When you compare that figure to the $4,000 up-front cost, it’s almost a no-brainer. But, the comparison should not be that straight-forward. There’s a lot more to consider when asking, “should you pay points on a mortgage?”
Should You Pay Points on a Mortgage
Whether you should pay points on a mortgage should depend on how long you plan to keep that mortgage. If you sell your home or refinance your mortgage, the slate is essentially wiped clean. Let’s go back to the example above.
If paying $4,000 up-front allows you to save $120 per month on your mortgage payment, the breakeven point is roughly 34 months ($4,000 / $120 = 34.18 months). So, you don’t actually start saving any money until the 35th mortgage payment. Are you likely to move or refinance your home loan before then? If you refinance your loan in 2 years, for example, the higher monthly payment would have cost you $2,808 rather than the $4,000 you paid in points at closing. So, you’ve essentially wasted your money since it would have cost you less to simply pay $117 more each month!
Always Look at the Big Picture
Nomatter what loan programs you are considering, always look at the big picture. Raw numbers are not always an accurate evaluation. Think realistically about your homeownership plans when reviewing any types of costs or fees. These include points, variable interest rates, and even pre-payment penalties on loans. Only by considering all of the facts can you make smart financial decisions.