Discount Points…
02/28/2008 – 12:32 pmShould someone pay points to get a lower interest rate or not. This is a very common question that a customer asks. Some clients like to pay points and some would rather not. When you pay “points”, you pay interest in a lum sum upfront to get a lower rate on your mortgage. Each “point” costs 1% of the loan amount. The more points you pay the lower your interest rate will be. As a rule of thumb, the interest rate is reduced by a quater of a percentage point for every discount point you pay. To decide, you need to consider how long will i live at this home. If you plan to sell the house or refinance within the 5 years, it propbably doesn’t make sense to pay discount points. On the other hand, if you plan to keep the mortgage for 10 years or more, you’ll save money in the long run.
Lets look at an example of a 400k mortgage with and without poits.
Loan Amount 400k
No points = 6.25% Monthly payment = $2,463
1 Point = 6% Monthly payment = $2,398 Savings of $65 per month with cost of $4,000. It would take just over 5 years to make up that $4,000.
2 Points = 5.75% Monthly payment = $2,334 Savings of $129 per month with cost of $8,000. Also just over 5 years to make up $8,000.
So the question is how does someone know if they will have the same mortgage or house in 5 years to get rewards of the lower interest rate. I guess noone can predict the future so you just have to ask yourself if this makes sense.
4 Responses to “Discount Points…”
When all factors are equal you will find it takes even longer to recoup points.
To illustrate, take John’s example of a $400,000 loan. The factor that is not equal is that by paying 1 point you have to come up with an extra $4,000 (1% x $400,000). Said another way, paying 0 points you could just borrow $396,000. This makes your payment $2,438 instead of $2,463. That means by paying 1 point you really only save $2,438 – $2,398 = $40.
Since your loan balance is now $4,000 higher, if you applied the $40 savings to principal each month it would take you $4,000 / $40 = 100 months to recoup the extra cost. If you didn’t apply it to principal it would take even longer. So in this example best case is 8.3 years to save money by paying points.
By Colin on Mar 1, 2008
What Colin says makes sense but there is an assumption being made that the buyer has to pay the discount points.
With the current buyers market why not get the best of both worlds? Negotiate a sellers credit to pay closing costs & a rate buy down. Then use your own money to pay down the total loan amount thus saving you even more.
By turtle on Mar 13, 2008
Turtle’s right on top of it. It was a Seller’s market for so long, lots of buyers have gotten used to not having the upper hand. For those Buyers, follow this link to learn more strategies to use in this buyer’s market:
http://www.crystalclearmarket.com/?p=14
By Elliot Lau on Mar 13, 2008
Point well taken. In reality having the seller pay is the most practical approach. Strictly looking at the numbers would still remain true. If the seller is willing to pay closing costs, then they should be willing to accept a lower price (net money to the seller will be the same). Keep in mind this idea of recouping has evolved with our changing lifestyle. If you buy a home and live in it for 30 years, then getting the lower rate does save money.
By colin on Mar 14, 2008