POINTS: MORTGAGE LOAN COSTS
Points are mortgage loan costs typically in association with an interest rate. One point is equal to 1 percent of the loan amount, so one point on a $200,000 loan is $2,000. It's good to pay them, right? Or wait, it's not good to pay them, right? The correct answer is "yes". It is good and it's not good. So how do you tell?
Points are often looked upon as "prepaid interest" hence the potential tax deductibility. If you paid points last year for your new home then you may be entitled to deduct those points from your taxable income before you send more money to Uncle Sam. Note, the tax deductibility can vary for points between purchase and refinance transactions. Points paid during a refinance are usually only deducted over the term of the mortgage. With a purchase, points may be tax deductible for the year paid.
If you pay points, you're paying your lender some of the interest up-front, in a single fee, in exchange for a lower rate. What's the difference in rate if you pay a point? Two points? There is no symbiotic relationship between rates and points, but generally speaking for each 1/2 point, you can drop your rate by 1/8%. Paying one point will drop your rate by a quarter percent, and so on. Again, there is no correspondent trade off between points and rates, but usually one point will get you 1/4%. So how do you decide? How do you decide whether or not to pay points? First calculate your monthly payments by paying a point then do run the same routine with paying no points. Let's say you've got a loan amount of $250,000 and you're quoted 7.00% with zero points. That's $1,653 per month in principal and interest for a thirty-year note. Your lender can also offer a rate reduction of 1/4% for one point. The monthly payment on a $250,000 note at 6.75% drops to $1,612, or a difference of $40 per month. Now divide that $40 monthly savings into that point you paid, or $2,500. The result is the number of months it will take to "recover" the cost of the additional funds to drop your rate. In this case, it would take just more than 62 months, or five years, to recover that money. On the other hand, your lender will make an additional $40 per month at the higher rate in lieu of your up-front $2,500.
Make sense? A lot of the decision rides on how long you anticipate keeping the mortgage in question, either by selling the property or refinancing later if rates drop. If you in fact don't anticipate keeping the house for a long time then paying additional points may not make much sense. But that $40 per month savings adds up to $14,400 more than thirty years. It's really not necessary to rely on outside "experts" to tell you if paying points is worthwhile or not. Do some of the math yourself, then determine if paying points are really in your best interest.