Feb 26 2009
Paying Points, How Much Does a Point Cost?
Everyday I speak to people about their mortgages and their options for home financing. When I get to the point where we talk about rates I will usually say something like “on a thirty year mortgage our current rate is 5.5% with no points, you can reduce that rate to 5.0% by paying one point.” The question that always comes up is “How much does a point cost?”
Simply put, a point is one percent of the mortgage amount. If the mortgage is $100,000 a point is $1,000. If the mortgage is $400,000 a point is $4,000.
Is it worth it to pay points?
Without looking at the math involved, I like to ask my borrowers a simple question. “What is more important, a lower monthly payment, or lower upfront costs?” Sometimes the answer is so resounding toward one side that I don’t need to go forward with any calculations. If the person has very little cash to spend now, but good income, we forget about points and move forward. If the person has a lot of cash now, but lives on a fixed income, points are likely to be helpful.
My next question is, “how long will you have this mortgage?” Let’s look at a simple case where someone is deciding between buying or not buying a point. Their proposed mortgage is for $100,000. The rate without a point is 5.5%, with one point it is 5.0%. At 5.5% the monthly payment is $567.79. At 5.0% the payment is $536.82, or $30.97 less. Since the point costs $1,000 we see that the break even point is after 32.33 months. So, if the borrower will be selling the home or refinancing in the next 3 years they will not get their money back. (This is really an over simplified calculation. A more accurate calculation would consider the extra principle paid on the loan by the lower rate, the tax implications of paying more or less interest, and the value of today’s dollars compared to the dollars spent in the future. However, the computation is close enough for most people’s use.)
An easy to use Mortgage Discount Point Calculator is helpful in deciding whether of not to buy points. For more information on mortgage points visit Paying Mortgage Points.
