December 7th, 2015 6:42 AM by Jackie A. Graves
points to get a lower rate on a mortgage is almost always a losing proposition.
That's because most homeowners don't keep their mortgages long
enough to do more than recoup the up-front cost of paying points.
A point is 1% of your loan amount. If you take out a $250,000
mortgage, 1 point equals $2,500.
In the mortgage world, there are two types of mortgage points:
Origination points are a fee you must pay a
bank or mortgage company to give you a loan.
Discount points (the focus of this
story) lower the interest rate on your loan and reduce your monthly payments.
Borrowers get a lower rate for paying discount points because
they're prepaying a portion of the interest on their
Indeed, discount points are tax-deductible, just like the
interest you pay with each monthly mortgage payment. (According to the IRS, 2.7
million of the 45.5 million federal tax returns filed in 2012 took a deduction
for discount points.)
How much can you lower your interest rate by paying points?
Anywhere from one-eighth to one-quarter of a percentage point
per discount point.
A range like that makes it absolutely critical to compare offers
that include points to those that don't and determine how much you're really
saving by paying thousands of extra dollars up front.
Some banks and mortgage companies actually promote interest
rates in their advertising that areonly available by paying points. They hope you'll be
so wowed by a rate that looks like it's lower than competitors are charging
that you won't notice the additional up-front cost.
The key question you need to ask is: How long will it take me to
recoup what I spend on points through lower monthly mortgage payments?
Considering two typical 30-year fixed-rate mortgages quickly
shows how much paying a point will save (or cost) you on a typical $100,000
Mortgage Option 1: 4% interest rate with no points
Mortgage Option 2: 3.875% interest rate with 1 point
Total Payments Over 30 Years
4%, No points
3.875%, 1 point
Savings from paying points
If you pay 1 point, or $1,000,
to get the 3.875% rate, you lower your monthly payments by right at $10 a
month. (Our mortgage calculator will determine the monthly payment for
any amount or interest rate.)
That means it would take 100 monthly payments, or more than
eight years, to recoup the up-front cost of that point.
You won't really start saving any money until then — and therein
lies the problem.
Chances are, you won't keep your loan much longer than that
since the typical homeowner pays off a loan in just over eight years, according
to data compiled by Bloomberg
Selling or refinancing before the break-even point means you'll
actually wind up paying extra
interest on the loan.
If you've just bought your dream home and know you'll keep your
low-interest mortgage until your kindergartner graduates from high school,
paying points may seem like a smart move.
With interest rates at historic lows, chances are you won't need
to refinance to reduce your rate.
But you might be forced to refinance or sell your home before
you break even on your points if you face an unexpected life challenge like
divorce, death of a spouse, disability or a job loss or transfer.
why Richard Bettencourt, a mortgage broker in Danvers, Massachusetts, and
secretary of the Association of Mortgage Professionals, says paying points
typically isn't a good financial move.
"The only way I see a point making sense is for that rarity
of the person who says, 'I'm going to make all 360 payments (on a 30-year home
loan) and never move,'" he says.
What about having a home seller pay points to buy down your
rate? Isn't that a good deal for a home buyer?
"Do you want the seller to reduce your monthly payment by
$20 for the next 30 years or give you $7,500 to refinish the kitchen now?"
Another way to look at points is to consider how much cash you
can afford to pay at the loan-closing table, says Mark Palim, vice president of
applied economic and housing research for Fannie Mae, a government-owned
company that buys mortgage debt.
"If you use up some of your savings toward prepaying your
interest, which makes your payment lower on a monthly basis, you have less
savings if the water heater breaks," he points out. "Does it make
sense to put more of your savings into the transaction to lower the monthly
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