Should You Pay Points?
A point is one percent of the overall loan amount that is paid up front, typically at the time of closing. For each point purchased the loan rate is typically reduced by 1/8% (.125) For example, if you are borrowing $150,000 on a mortgage loan and will be paying three points, you will pay $4,500 up front and will reduce your interest rate by approximately .375%. By paying points you are simply buying down the rate of your loan which translates to lower monthly payments.
As you plan and budget for the years to come, you may find that you’d like to have a lower monthly mortgage payment. One way to accomplish this is by paying points.
Another advantage of paying for points on a residential mortgage is that you can deduct the money you pay on that year’s income tax return. (This applies only to new mortgage loans. If you are buying points to refinance your home, the IRS considers this prepaid interest. That means you will have to deduct them over the life of the loan rather than all at once at closing). Of course there is also the matter of your down payment and thus the availability of funds will likely be a major consideration.
If you can afford to pay points you’ll want to figure out if it’s worth it. When determining whether you should pay points, you’ll want to think about how long you plan to live in the house. Here’s a general rule of thumb: the longer you’ll keep the loan, the more attractive points become. Less than five years? Paying points usually doesn’t makes sense, as you will pay more in points than you will save in interest over the length of the loan. However, if you plan to stay in the house for 10 years or more years, points will pay off over time. Although the prospect of paying a few thousand dollars upfront may not sound like an attractive idea, you may be able to save money over the duration of the mortgage.
When shopping for a mortgage, factor in your loan with points and see when you will break even. If you see that by paying $2,000 for two points you will break even in 7 years, and you plan to stay in the house for at least 15 to 20 years, you will come out ahead.
You can finance points, which allows you to pay them off as part of the loan. But this increases the cost of your points, and it will take longer to break even, thus if you can, pay for the points in full at closing.
Click here for a calculator that will simply the process of determining if you should pay points
