What are Mortgage Points? Should I Pay Them?

Many people don?t really know what ?points? are when it comes to discussing their mortgage. Simply put, points are paid by a borrower to a lender to reduce the rate on a mortgage. each point represents a percentage point of the whole loan value. If, for example, you pay one point on a $100,000 loan, you will pay $1,000 at closing.

Points lower the rate of the mortgage for the term of the mortgage. Points, however, are used in different ways by different lenders, so that one point at one bank may reduce your loan by 3/8%, whereas at a different lender it may be worth ?%.

The main issue for whether or not you should pay points is how long you think you will have the mortgage, since paying the upfront cost, and moving out 2 months later makes no sense. If you have to borrow to pay the points, you will most likely lose any advantage since you will have the additional interest. If this is a starter home, and you are hoping to move up to a bigger home in a few years when you start a family, paying points is probably not a good idea, and here is why.

Points should be viewed as an investment in the mortgage. Let?s say you?re considering paying 1.5 points to get a reduction in your home loan rate from 6.00% to 5.50%. It is a bit like prepaying some of your mortgage interest bill.

For your convenience, there are calculators available on the internet that can tell you whether it is worth while to pay points or not.

Here is how the idea works: If you pay $1,500 in points, you may be able to lower your mortgage rate to 5.5%. How do you find the breakeven point in this situation, based on the different rates? A $100,000, 5.5% fifteen year mortgage will have a payment of $599.55 per month. The cost of a $100,000, 30 year loan at 6% is $567.79 a month.

The points paid will save you $31.76 a month, but you had to give your lender $1,500 in order to reap this savings. When you divide that $1,500 by the savings of $31.76, it would take you almost 4 years, 47.23 months, to recover the initial outlay. In other words, if you don?t think you?ll be in the home for about 4 years, you get nothing by paying the points.

After that point, however, the upfront investment of $1,500 is covered, and you will now save a total of $31.76 each month. If, a very big if in today?s mobile society, you owned your home for the full thirty years of the mortgage, and multiply the $31.76 per month savings for thirty years, you would save $9,933.58 over the entire term of the loan!

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