a lot of people don?t really know what ?points? are when it comes to negotiating their mortgage. In simple terms, points are paid by a borrower to a lender to reduce the rate on a mortgage. One point is 1% of the loan. A $100,000 requires a $1,000 payment for one point.
Lenders use these upfront payments to reduce the long term cost of the mortgage. The ratios change, depending on the market and the bank, but here is an example for a mortgage at 6.25%: if you pay one and one half points, you will reduce the mortgage rate to 5.875%, if you pay 2 ? points, you would reduce the rate to 5.375%.
The test is how long you will live in the home since the cost of the points goes down as time passes. Borrowing to pay points makes little sense, since the idea is to save interest, not pay it. For many first time home purchasers, points are not a good idea, since they may want to move to a different home in the near future.
As a rule, points are a deposit on your interest rate that you will draw against over the life of the loan. Let?s say you?re considering paying 1.5 points to get a reduction in your home loan rate from 6.00% to 5.50%. Actually, you are paying a part of the interest ahead of time, so if you are only going to have the mortgage 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%. You have to find the breakeven point on how valuable this $1,500 investment will be. The cost of a $100,000 15 year mortgage at 5.5% is $599.55 a month. A $100,000 6%, thirty year mortgage will have a payment of $567.79 per month.
This is a clear savings of $31.76 per month, but remember you had to pay $1,500 to receive this savings. All you have to do is divide $1,500 by $31.76 and you will see that it will take 47.23 months for the payment to be fully amortized. You have to count on living in your home for at least 3 years, 11 months, for the points to have been worthwhile.
After that point, however, the upfront investment of $1,500 is covered, and you will now save a total of $31.76 each month. If, a very big if in today?s mobile society, you lived in your home for the full thirty years of the loan, and multiply the $31.76 per month savings over thirty years, you would save $9,933.58 over the entire term of the loan!