Typically, banks and other financial institutions offer borrowers the option of purchasing discount “points” in exchange for lower mortgage rates. Should you buy mortgage points? The answer, of course, depends on your situation. Here’s a primer:
On a 30-year mortgage, paying one point — one percent of the mortgage amount — lowers the interest rate by about .125 percent. This means, for example, if you pay a point of $2,000 on a $200,000 mortgage, you’ll get an interest rate of 6.0 instead of 6.125 percent.
Sounds like small potatoes, doesn’t it? But over the life of a 30-year fixed mortgage, that small change in interest rate can mean substantial savings.
To decide whether paying points makes sense for you, it’s important to determine the “breakeven” point. That’s the number of months you’ll need to stay in the home to recover the cost of any points paid upfront.
First, you need to determine the projected monthly (principal and interest) payments without buying points.
Next, determine the monthly payment if points are paid. Subtract the smaller payment (with points) from the larger (without points) to find your monthly savings.
Lastly, divide the cost of the points by your projected monthly savings. The result will be the number of months required to break even.
Let’s say, for example, you’re considering a $200,000 fixed rate mortgage for 30 years at 7 percent. At that interest rate, the projected monthly (principal and interest) payment would be $1,330.60.
By paying one point ($2,000) up front, you can lower the interest rate by .125 percent. The payment then becomes $1,313.86 ($16.74 less per month).
Under this scenario, the breakeven point is calculated at 119 months or almost ten years ($2,000 divided by $16.74). If you change homes in less than 10 years, you won’t recover the $2,000 you paid to lower the interest rate.
On the other hand, if you stay in the home for the next 30 years, you’ll save about $16 a month from year ten to year thirty, a savings of over $4,000.
In general, the longer you’re planning to stay in the home, the more sense it makes to pay mortgage points. If you’d like help deciding whether mortgage points are the best choice for you, give us a call.
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