Choosing How Many Points You Want to Pay on Your Home Loan
If you don?t comprehend the concept of points, you have come to the right place. Points are fees that one pays to the lender at the closing of the mortgage. One point is 1% of the mortgage. In other words, if you are asked to pay 1 point, you would have to pay $1,000 on a $100,000 loan.
Points lower the rate of the mortgage for the term of the mortgage. The ratios change, depending on the market and the bank, but let?s take an example for a mortgage at 6.25%: if you pay one and one half points, you will lower the home loan rate to 5.875%, if you pay 2 ? points, you would reduce the rate to 5.375%.
The longer you will live in the home, the more sense it makes to pay points; you also have to decide whether you can afford to pay the points. If you have to borrow to pay the points, you will most likely lose any advantage since you have to pay the additional interest. For many first time home buyers, points are not a good investment, since they will want to move to a different home in the near future.
You have to look upon points that you pay as an investment in your loan. Paying 1.5 points to reduce your mortgage from 6% to 5.5% is an investment, but is it a smart one? Actually, you are paying a part of the interest ahead of time, so if you are only going to have the home loan a short while, you have paid that advance interest for nothing.
It can be calculated whether or not it makes sense for you to pay points, depending on the length of time you will be in your home; use one of the many calculators on the internet or ask a mortgage consultant to do it for you, free of cost.
For our hypothetical $100,000 mortgage, you would have to pay $1,500 in points to receive the interest rate reduction to 5.5%. Then it is a question of finding the breakeven point, by examining the mortgage payment differences between the two rates. A $100,000, 5.5% fifteen year mortgage will cost $599.55 per month. For a 30 year maturity, it would be $567.79.
Since the reduced rate saves $31.76 per month, you have to at this point compare that to what the upfront payment in points cost you. When you divide that $1,500 by the savings of $31.76, it takes almost 4 years, 47.23 months, to recover the initial outlay. That makes the decision simple; if you do not expect to be in your home at least 47.23 months, the points do not give you any advantage.
After that point, however, the initial investment of $1,500 is covered, and you will now save a total of $31.76 each month. That can be a real savings if you keep your home for thirty years and save $31.76 a month; as a matter of fact, it will add up to $9,933.58!