| Mortgage
Points
What
are they and should I pay for them? |
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If you are in the market for a
new home, you have probably been
watching the mortgage interest rates.
You have probably also noticed ads
by banks or mortgage companies that
mention "points". What
are "points", should I
pay them, and most importantly how
will the "points" affect
my mortgage?
There are two types of mortgage
points: origination points and discount
points. We will examine both types
of points in this article.
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Origination Points
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Origination
points are basically used to compensate
the company/loan officer who is writing
the loan. The origination point is
equal to 1% of the total amount of
the mortgage, not the home value.
For example, one point on a $100,000
mortgage is equal to $1,000. This
fee is paid up front and the origination
points are not tax deductible. Not
every company will charge origination
points, and typically the rate charged
is different from lender to lender.
If the company you are using charges
origination points try to negotiate
them. The mortgage lending business
is extremely competitive right now,
so if one company will not budge on
their fees, there are others that
will.
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Discount
Points |
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Discount points are a way to buy a
better rate on your mortgage loan. For
the lender however, discount points
are just prepaid interest to them. Each
discount point will cost 1% of your
mortgage and will lower the rate by
0.25%. If your mortgage is $100,000
with an interest rate of 6.0% but you
want to lower the interest rate to 5.5%
it would cost you 2 points (0.25% x
2 points = 0.50%) (6.0% initial interest
rate - 0.50% = 5.50%). One point will
cost you $1,000 ($100,000 mortgage x
1% = $1,000). Since we purchased 2 points,
it will cost us $2,000 up front to lower
our interest rate by 0.50%. The discount
point rate can vary between lenders
and it follows the fluctuations in the
bond market, however it very seldom
differs from the standard 0.25%.
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| Should
I pay for points on my mortgage? |
The argument
for buying points or not buying points can only
be decided by you and your personal situation.
There are pros and cons for both sides of the
argument and depending on your situation, the
pros could be cons or the cons could be pros.
Both sides of the argument will be discussed
neutrally and hopefully this will help in the
decision making process. As with any financial
decision, do your research.
Before making the decision to buy or not buy
points, the following questions should be asked:
Do I have extra cash to pay the points? How
long do I plan on keeping the home? Should I
save the money for an emergency? Does a smaller
monthly payment benefit me financially; could
I earn more investing the money elsewhere? All
of these are good questions that need to be
answered, but in my opinion, the most important
questions is "How long do I plan on keeping
the home?" Statistics say that the average
mortgage lasts about seven years, but keep in
mind your situation might not be the same as
the average. Is your job and industry stable,
and is there a chance the company could move
you? Is your home a starter home? Will the bedrooms
be ample for the amount of kids you plan to
have in the future? Are you rooted to the community
for family or other reasons?
Let's put together a hypothetical example of
what would happen on a $100,000, 30 year mortgage
with an interest rate of 6.0% if you do pay
points or you do not.
|
|
Discount Points: |
0 |
1 |
|
2 |
|
| Cost
(Points) |
$0.00 |
$1,000.00 |
|
$2,000.00 |
|
| Interest
Rate |
6.00% |
5.75% |
|
5.50% |
|
| Monthly
Mortgage Payment |
$599.95 |
$583.57 |
|
$567.79 |
|
| Total
Out of Pocket |
|
Savings/Loss |
|
Savings/Loss |
| Year
1 |
$7,194.60
|
$8,002.84
|
($808.24) |
$8,813.48
|
($1,618.88) |
| Year
2 |
$14,389.20
|
$15,005.68
|
($616.48) |
$15,626.96
|
($1,237.76) |
| Year
3 |
$21,583.80
|
$22,008.52
|
($424.72) |
$22,440.44
|
($856.64) |
| Year
4 |
$28,778.40
|
$29,011.36
|
($232.96) |
$29,253.92
|
($475.52) |
| Year
5 |
$35,973.00
|
$36,014.20
|
($41.20) |
$36,067.40
|
($94.40) |
| Year
6 (Break Even) |
$43,167.60
|
$43,017.04
|
$150.56
|
$42,880.88
|
$286.72
|
| Year
7 |
$50,362.20
|
$50,019.88
|
$342.32
|
$49,694.36
|
$667.84
|
| Year
8 |
$57,556.80
|
$57,022.72
|
$534.08
|
$56,507.84
|
$1,048.96
|
| Year
9 |
$64,751.40
|
$64,025.56
|
$725.84
|
$63,321.32
|
$1,430.08
|
| Year
10 |
$71,946.00
|
$71,028.40
|
$917.60
|
$70,134.80
|
$1,811.20
|
| Year
20 |
$143,892.00
|
$141,056.80
|
$2,835.20
|
$138,269.60
|
$5,622.40
|
| Year
30 |
$215,838.00
|
$211,085.20
|
$4,752.80
|
$206,404.40
|
$9,433.60
|
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As you
can see from the chart above, it takes 6 years
to come to a breakeven point. Being that the
average homeowner stays in a home for 7 years,
is paying the points worth it in this situation?
If you pay 1 point and hold the loan for 30
years the chart shows a savings of $4,753, and
if 2 points are paid a savings of $9,433.60.
The above chart does not take into account interest
earned on the money used to buy points, if it
would have been saved in an interest bearing
account or income tax considerations.
Let's say instead of buying points, you keep
the money and invest it in an interest bearing
account, cd, etc... For the sake of the example,
let's say we earn a safe 5% on our investment,
compounding monthly for 30 years. $1,000 would
become $4,467.74, and the $2,000 would equate
to $8,938.49. Let's view the differences.
|
| 1
point ($1,000) - 30 year savings on Mortgage
= $4,752.80
2 points ($2,000) - 30 year savings on Mortgage
= $9,433.60
|
|
$1,000 invested at 5% for
30 years = $4,467.74
$2,000 invested at 5% for 30 years = $8,938.49
|
1 Point - Mortgage savings ($4,752.80)
- Investment ($4,467.74) = $285.06 saved
by paying for 1 Point.
|
2 Points - Mortgage savings ($9,433.60)
- Investment ($8,938.49) = $495.11 saved
by paying for 2 Points.
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| In
this example, over 30 years you would save
$285.06 by paying 1 point and $495.11 by paying
2 points. Is this savings worth the risk?
Keep in mind statistics say most people move
after only 7 years. The numbers used in this
example are small, so the situation may make
more sense if the home mortgage price is a
higher number. What if mortgage rates drop,
since points have already been paid for, it
might make it harder to refinance to a lower
rate before the break even period.
Each and every person's financial and personal
life is different, so it is hard to argue
whether to purchase points or not. I hope
the examples above helped in understanding
what points are and how they actually work.
Remember to always do your research and decide
what is best for you in your situation. I
have even seen a few "Should I Pay Points?"
calculators on the web that might help you
in your decision making process.
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