"Points" are, for many first-time homebuyers and even for homeowners thinking about refinancing, often misunderstood. Points are nothing more than interest paid up-front at closing in order to obtain from the lender a lower interest rate on the mortgage. This article shall examine why this is something you may wish to do.
First, let us define “point" as 1% of the amount of the loan, the amount you are borrowing. If you are borrowing $200,000, one point on that loan is $2,000. And paying that 1 point up front as “pre-paid interest" can usually reduce the interest rate on the loan by .25 to .375%, depending on the lender and what type of loan you are getting.
It can make good sense to pay points to reduce your loan's interest rate if you plan to keep the loan for a longer period of time. Over a few years, having a lower interest rate will off-set the points paid up front. Notice I did not say, “keep the property", but “keep the loan" for a longer period of time. You may very well own that property for many years but you may currently be contemplating a loan product which you will want or need to refinance out of in a few years. Maybe there is a balloon payment, or it is an adjustable-rate mortgage (ARM) with an initial 3 or 5-year “honeymoon" low interest rate that will recast upwards eventually. Basically, you want to be in the loan long enough to recoup the points you paid up front and see some advantage from the lower interest rate thus obtained.
And as pre-paid interest, if the loan is for your primary residence, the points are tax-deductible as mortgage interest. Consult your CPA for what value that translates into for you in your particular tax bracket.
Let's work through an example. You are borrowing $200,000. You choose to pay one point at closing, $2,000, and that saves you $100 per month on your monthly mortgage payments. It will take you 20 months to off-set that $2,000 paid at closing. If you sell or refinance before then you will have wasted money. But from month 21 onwards, you are now enjoying the lower interest rate and putting $100 in your pocket every month that would otherwise have to go to a higher monthly payment.
Look as well at where interest rates are at when you take the loan. If interest rates are high and may head downwards in the next few years, paying points to get an artificially lower rate now may not make sense, because 2 years down the road you will be re-financing again to obtain a loan at the then-current and lower rates. If interest rates right now are about as low as you believe they will be for a few years, then lock in as low a rate as you can get with points.
In this matter, it is advisable to seek the counsel of a good mortgage planner who can educate you on your options and interest rate trends.
James Hussher is a Certified Mortgage Planner and licensed in all 50 states. Please visit James at http://ezmortgages123.com for all of your residential and commercial mortgage needs. Apply online, check current offered rates and loan programs and more! Many free articles and educational resources may be accessed at http://swifthussherrealestate.com which James also runs!