Does Paying Points on a Mortgage Make Sense
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Does Paying Points on a Mortgage Make Sense?
Exploring the Benefits and Drawbacks
You've found your dream home and are shopping for a mortgage. Several lenders have mentioned the concept of points, suggesting that paying them is the way to secure a low interest rate. But is it really worth increasing your initial costs for a reduced rate?
Understanding Points
Points, also known as discount points or origination fees, are fees you pay to the lender at closing. Each point is worth 1% of the loan amount and essentially allows you to "buy down" the interest rate.
A Historical Perspective
Points gained popularity in the early 1980s when mortgage rates soared above 15%. Buyers couldn’t afford the high monthly payments, so lenders started offering discounts in exchange for points. Sellers often paid these points to facilitate sales. In this way, buyers got affordable mortgages, while sellers moved their properties.
Today's Market
Today, interest rates are more reasonable, reducing the necessity of paying points upfront to secure a lower rate.
A Quick Case Study
Consider purchasing a home for $240,000, with a 20% down payment, leaving you with a $192,000 mortgage. A lender offers a 30-year fixed-rate mortgage at 6.5% with two points, costing you $3,840 at closing. Alternatively, a 7% rate is available with no points. Which is better?"a lower rate or lower closing costs?
- 6.5% Interest Rate: Monthly payment is $1,207.
- 7% Interest Rate: Monthly payment is $1,270.
This difference amounts to $63 per month. However, when factoring in potential interest earnings on your $3,840 over six years?"assuming a 3% interest rate?"you'd earn around $10 per month. Thus, the effective savings is $53 per month. This extends your payback period to 72 months, or six years.
Key Considerations
To truly benefit from paying points, you must live in your home for at least six years. Most people do not keep a mortgage for that long, so unless you're certain of staying put, it might be wise to invest your money elsewhere.
If reducing your monthly payment is a priority, consider looking at less expensive properties. A $60 savings per month may not be significant if you're on a tight budget, and finding extra money for closing costs could pose a challenge. Avoid taking out a loan to pay points, as it would counteract the benefits.
In summary, while paying points can lower your mortgage rate, it’s essential to evaluate your long-term plans and financial situation. Carefully assess whether the initial cost is justified by the potential savings.
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