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:

Loan 1
Loan 2
Interest Rate
Points Required

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.

Tax Benefits
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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