Should You Pay Mortgage Points?

The interest rate on the loan will almost always be presented alongwith points. One point is equal to 1% of the loan value. If youchoose to pay points, you will be paying money to the lenderupfront. The upfront paymentwill 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% interestfor 30 years. The lender may give you the option of paying pointsupfront and offer an interest rate of 5.69% for 2.5 points.Generally for every point paid on a 30 year fixed rateloan 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
5.69%
6%
Points Required
2.5
0


The monthly payment on the loan with no points wouldhave been $1,199. However if you pay the 2.5 points or $2,500 upfront, themonthly payment would be $1,160. To find out how long it will take you torecover the point payment, take the amount paidin 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 rateif 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 theannual percentage rate (APR) of a loan. The idea is to make it easier to determineif a 30 year fixed rate loan at 8% and no points is better than a 7.75% loan with 2points. Also the annual percentage rate includes prepaid finance charges such as theloan origination fee. Because of these added amounts the annual percentage rate willalways be higher than the lender's quoted rate.

Tax Benefits
The payment of points when acquiring a loan allow for a tax deduction. The paymentin points are tax deductible in the year they were incurred. So in our above examplethe 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 lifeof the loan. However it is important to calculate how many months before the point paymentsaves you money, especially if you are thinking about selling your house in the future.

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