It depends. Whether or not it makes financial sense to pay points typically depends on how long you are going to keep your loan. When you pay a point, you are paying money upfront to lower your interest rate. A lower interest rate means that you will have a lower monthly payment (because the interest portion of your monthly payment will be lower), saving you money each month over the life of the loan.
This is usually a good financial deal if you plan to keep your loan for the full period. The amount you save each month over the life of the loan is much higher than the original price you paid for the point. However, most people only stay in their home for a couple of years or refinance before they pay off their loan. If you move or refinance before you have recouped the money you paid for the point, you will be losing money. So what you want to do is calculate how long it will take to recover the cost of a point and then decide whether or not you think you will still have the loan after that amount of time.
Let’s look at an example.
Scenario: $250,000 30-year fixed loan with $2,000 in fees. Option 1 is 5% with no points, and option 2 is 4.75% with one point (the point costs $2,500, or 1% of the loan, and is added to the fees).
So you can see that with an upfront payment of $2,500 for the point, you will save $37.93 per month, which equals a total savings of $11,155 ($13,655-$2,500) over the life of the loan! That is a big discount. I used this monthly payment calculator to generate these values.
Next, let’s graph both of these scenarios showing your total savings over time and your breakeven point. The graph below shows the cumulative dollars you will save in each scenario. In scenario 1, you will save $2,500 because you will not pay the point. In scenario 2, you will save $37.93 each month as a result of the lower interest rate. The total savings will continue to grow each month over the life of the loan. You will notice that option 1 is better if you have the loan for 66 months or less (because you save the $2,500 by not paying the point). However, if you have the loan for more than 66 months, option 2 is better since you will recoup the cost of the point and reap additional savings each month afterwards.
An easy way to calculate your breakeven point is to divide the cost of the point by the amount you will save each month (monthly payment 1 – monthly payment 2). This is the number of months it will take to break even. In this case it is $2,500/$37.93 = 66 months.
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Comments
10 Comments so far
Should I pay points on my home loan? | Mortgages Unzipped | Home Loan Rates
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Justin McHood
Nate,
Great post!
Simply put: the longer you plan to stay in the loan, the more sense it makes to pay points.
Plan to stay in the loan for 30 years?
You might want to look at paying as many points as you possibly can.
Justin
Brian Brady
“An easy way to calculate your breakeven point is to divide the cost of the point by the amount you will save each month (monthly payment 1 – monthly payment 2). ”
Nate,
This is the common mistake most laypeople make. Total Costs Analysis is a more accurate way to determine breakeven because it isn’t tainted by principal paydown:
http://www.bloodhoundrealty.com/BloodhoundBlog/?p=7628
Nate Moch
Brian,
Thanks for the comment and the link. Good point. I agree the Total Cost Analysis you described is more accurate. That said, I still think the simple break even calculation is a pretty good tool to quickly assess the general time it would take to make back the paid point (since it is so easy to use).
Thanks,
Nate
Brian Brady
“That said, I still think the simple break even calculation is a pretty good tool to quickly assess the general time it would take to make back the paid point”
Agreed. A great “rule of thumb”, Nate
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Lindsay Scott
Dear Nate,
Good article but it is also very important to consider the pricing of that point. When pricing is packed more closely together, it is more worthwhile to buy down the rate because you can get more of a rate reduction for your point. Conversely, when rates a priced farther apart it is a better time to charge a higher rate to cover some of the borrowers costs as you get more dollars for a smaller jump in rates. How long they will be in the house, loan size, and their personal preferences always have to be considered.
Thanks,
Lindsay
quy
totally good stuff to learn from your knowlege
JackA
Morning,
Thanks for the informative post. I have been looking at Amerisave products that come with their proprietary surefee costs instead of points and fees. They will not change their surefee into points — I have asked, begged. So, is the surefee tax deductible? From what I have read (including the tax code) it looks like they are not deductible. So, they offer a very competitive product, but if you can’t deduct the surefee, it seems like a ‘no brainer’ to go with a company that charges standard points. Am I missing something?
–jack
Loan Modification
Thanks for sharing this informative post.