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Published: Oct 14, 2009 |
24 Comments

When people ask whether to pay up-front "points" on a mortgage loan, it brings to mind an old motor oil ad. A mechanic is holding some worn engine parts and telling us why we should opt for the premium lubricant rather than Brand X.

"You can pay me now," he says, "or you can pay me later."

The same principle applies to the question about points. You can "buy" a lower interest rate today by paying a point or two (one or two percent of the loan amount), also known as an origination fee ("pay me now"). Or you can avoid the points today and accept a higher rate ("pay me later"). Unlike the motor oil question, this one has no obvious answer.

The following enlightened view comes from Jack M. Guttentag ("The Mortgage Professor"):

*"Paying points can be viewed as an investment that yields a return that rises the longer you stay in your house. The return consists of the saving in monthly payment resulting from the lower interest rate, plus the lower loan balance in the month the loan is paid in full. This return can be compared to the return on other investments available to you over a similar time horizon."*

Consider two offers for a $100,000 loan. Loan A has a lower interest rate of five percent, but you have to pay one point (or $1,000) to get that rate. Loan B has a higher rate of six percent with no points. Calculating your real return on that $1,000 investment depends on additional factors such as your tax bracket, but, assuming you stay in the home for 30 years, the annual rate of return on your $1,000 investment is better than 60 percent even after taxes. In this case the one-point fee is a tremendous investment.

The math is complicated, but the general conclusion is a no-brainer, especially when you use a mortgage payment calculator such as the one on Trulia. With Loan B at six percent interest, the monthly payments come to $599. With Loan A at five percent, they are $536. Think of the $63 monthly savings as the "return" on your $1,000 investment. Now try to think of another way to make $63 every month for 30 years by investing $1,000 up front.

This example is an illustration, and usually the advantages aren't so stark. And, had you needed to relocate and left the house after a year, your $1,000 "investment" would have been a loser. But you get the idea. When considering points, think of them as an investment and then run the numbers.

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## Comments

Damian Warwick atlantahomeloan

And for my clients as long as that math supports - we are good.

Next time you write an article about points I would hope you would take the entire country into consideration. It is fine to pay points on a $100,000 dollar place as the cost is low, but what if you are in Massachusetts buying a $900,000 dollar condo and only expect to be there for 5 years. Will your 1/8 of a point buy down be recouped in 5 years if it cost you $9,000 dollars. I just feel that your article could have had so much more power if more properly focused. Best

Shawn Hood

Innovative Mortgage

Cell: 813-446-9695

Even more important, in the year you pay off the loan -- because you sell the house or refinance again -- you get to deduct in one fell swoop all of the as-yet-undeducted points. Thereâ€™s one exception to this sweet rule: If you refinance a refinanced loan with the same lender, you add the points paid on the latest deal to the leftovers from the previous refinancing -- and deduct that amount gradually over the life of the new loan.

http://www.donmaher.com/docs/analysis.pdf

Also, the article in the beginning of this thread mentioned origination points as a way to buy a lower rate. That is not really correct, origination points go into the lender and the loan officers pockets and does not affect the interest rate. Just an FYI for all.

Friday's pricing as example:

30 Year Fixed Rate (conventional up to $417,000):

This is a 15-day lock as an example

Rate Points (or lender credit)

3.99% (.875%)

3.875% .125%

3.75% 1.3750%

At a rate of 3.99%, my company, Provident Federal Savings Bank is paying the buyer or homeowner .875% points for their closing costs.

At 3.875% the buyer/homeowner is paying .125% points

At 3.75%, the buyer/homeowner is paying 1.375% points

For me, I would not advise that the client take a 3.75%. It is just not worth if for an 1/8th of a point drop in rate. I.e. on a $200,000 loan, 3.75% = $926.23 PI payment; on a $200,000 loan, 3.875% = $940.47.

So as you can see in this example, the payment savings = $14.24 a month. However the cost in points = $2,750. $2,750/$14.24 = 193 mos to break even or 16.09 years.

On the flipside, however I would go up in rate and get the lender credit. I.e. at 4.125%, we are paying 1.375% in lender credit. In that example the buyer/homeowner pays about $16 higher in monthly payment but we pay .50% higher in "rebate." That jump represents another $1,000 in lender credit on a $200,000 loan. **Points work both ways so I always look at our spread and what makes most sense for the client! :)

http://www.timesharescam.com/blog/135-timeshare-points-for-sale/

http://www.lawyerbuckscounty.com/tenant-eviction-lawyer/