Should You Pay Mortgage Points?
The interest rate on the loan will almost always be presented along
with points. One point is equal to 1% of the loan value. If you
choose to pay points, you will be paying money to the lender
upfront. The upfront payment
will result in a lower interest rate over the life of the loan.
So for example say you are going to borrow $200,000 at 6% interest
for 30 years. The lender may give you the option of paying points
upfront and offer an interest rate of 5.69% for 2.5 points.
Generally for every point paid on a 30 year fixed rate
loan the interest rate will decrease approximately 1/8 of a percentage point.
Two different loans are presented in the table below:
The monthly payment on the loan with no points would
have been $1,199. However if you pay the 2.5 points or $2,500 upfront, the
monthly payment would be $1,160. To find out how long it will take you to
recover the point payment, take the amount paid
in points and divide it by the monthly savings.
Number of Months to Recover Point Payment = Amount Paid in Points / Monthly Savings
So for our example:
Number of Months to Recover Point Payment = $2,500 / $39 = 64 months = 5.3 years
In our example it would make sense to pay points and get the lower interest rate
if you plan to stay in the house for more than 5.3 years.
The Annual Percentage Rate (APR)
According to a truth-in-lending law passed by Congress, lenders must show the
annual percentage rate (APR) of a loan. The idea is to make it easier to determine
if a 30 year fixed rate loan at 8% and no points is better than a 7.75% loan with 2
points. Also the annual percentage rate includes prepaid finance charges such as the
loan origination fee. Because of these added amounts the annual percentage rate will
always be higher than the lender's quoted rate.
The payment of points when acquiring a loan allow for a tax deduction. The payment
in points are tax deductible in the year they were incurred. So in our above example
the amount paid in points, $2,500 can be deducted on that year's taxes.
The payment of points on a loan can definitely be a way to save money during the life
of the loan. However it is important to calculate how many months before the point payment
saves you money, especially if you are thinking about selling your house in the future.
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