If you don?t understand the concept of points, you have come to the right place. The idea is fairly simple: you pay points up front to lower the interest rate on your loan over the entire period. each point represents a percentage point of the whole mortgage balance. If, for example, you pay one point on a $100,000 mortgage, you will pay $1,000 at closing.
The purpose of points is to lower the overall interest rate on the mortgage. Points, tough, are used in different ways by different lending institutions, so that one point at one bank may reduce your loan by 3/8%, whereas at another lender it may be worth ?%.
The main issue for whether or not you should pay points is how long you think you will have the mortgage, since paying the upfront cost, and moving out 2 months later doesn?t make sense. Borrowing to pay points makes no sense, since the idea is to save interest, not pay it. If this is a starter home, and you are hoping to move up to a bigger home in a few years when you start a family, paying points is probably not a great idea, and here is why.
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 mortgage rate from 6.00% to 5.50%. What you are really doing is paying some of your mortgage interest ahead of time.
Using any one of the mortgage point calculators on the internet, or by consulting with a mortgage consultant, you can calculate how much you will save in monthly payments on your mortgage, based on how long you will hold the loan.
Let us go back to our $100,000 loan that may be reduced to 5.5% if $1,500 were paid in points. It is necessary 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 per month. A $100,000 6%, thirty year mortgage will cost $567.79 per month.
The points paid then save you $31.76 a month, but you had to give your lender $1,500 in order to reap this savings. All you have to do is divide $1,500 by $31.76 and you will realize that it will take 47.23 months for the payment to be fully amortized. That makes the decision simple; if you do not expect to be in your home at least 47.23 months, the points do not gain you any advantage.
However, once the 47.23 months have passed, each month payment is a savings. If, a very big if in today?s mobile society, you owned your home for the full thirty years of the loan, and multiply the $31.76 per month savings for thirty years, you would save $9,933.58 over the entire term of the loan!