points is in essence a trade off
between paying money now versus
paying money later."
What are points?
Points are interest fees paid on a loan that reduce
your monthly interest rate by requiring prepayment of
a small percentage of the total interest due. The number
of points owed is up to your lender. For instance, a
one point loan will always have a lower interest rate
than a no point loan. Each point equals 1% of the total
So are points good or bad?
It depends on how long you are looking to keep the loan.
We suggest paying points up front if you plan on keeping
the loan for at least four years to ensure that you
recoup the costs through lower monthly payments. Another
benefit to points is that they are tax deductible.
However, if you think that you might move within the
next four years or might want to refinance because the
market rate is declining, then you probably would be
better off with a no point loan.
Points are typically the largest cost associated with
getting a home mortgage. Each point represents one percent
of the mortgage balance, or $1,000 for each $100,000
financed. Unlike other costs, points can not be financed
into your payment and must be paid with cash at the
close of escrow. The most common type of points are
discount points. These are fees paid by the borrower
to reduce the interest rate of the loan. The more points
you agree to pay upfront, the lower your interest rate
will be. Deciding whether or not to pay points depends
on many factors including the amount of cash you have
available after making the down payment, the amount
of the discount and the length of time you plan on owning
the house. You'll have to take a good look at the costs
and payment schedule of different types of loans to
decide which one is best for you. If you do not have
extra cash to pay points, but still want to lower your
interest rate, there's still hope. Some sellers are
willing to pay the discount points or other closing
costs in order to sell the property. It's worth asking,
even if you have the money to pay. If you're being moved
by your company, your relocation package may have a
provision to help you reduce you monthly payment.
The best way to decide whether you should pay points
or not is to perform a break-even analysis. This is
done as follows:
1. Calculate the cost of the points.
Example: 2 points on a $100,000 loan is $2,000.
2. Calculate the monthly savings on
the loan as a result of obtaining a lower interest rate.
Example: $50 per month.
3. Divide the cost of the points by
the monthly savings to come up with the number of months
to break even. In the above example, this number is
40 months. If you plan to keep the house for longer
than the break-even number of months, then it makes
sense to pay points; otherwise it does not.
4. The above calculation does not take
into account the tax advantages of points. When you
are buying a house the points you pay are tax-deductible,
so you realize some savings immediately. On the other
hand, when you get a lower payment, your tax deduction
reduces! This makes it a little difficult to calculate
the break-even time taking taxes into account. In the
case of a purchase, taxes definitely reduce the break-even
time. However, in the case of a refinance, the points
are NOT tax-deductible, but have to be amortized over
the life of the loan. This results in few tax benefits
or none at all, so there is little or no effect on the
time to break even.
If none of the above makes sense, use this simple rule
of thumb: If you plan to stay in the house for less
than 3 years, do not pay points. If you plan to stay
in the house for more than 5 years, pay 1 to 2 points.
If you plan to stay in the house for between 3 and 5
years, it does not make a significant difference whether
you pay points or not!