What are Points?
When shopping for a mortgage, many lenders will quote you rates with points or you can ask for a rate with points. Each point represents one percent (1%) of the amount you are borrowing. Generally, paying points should lower the interest rate on a loan. The more points you pay, the lower the interest rate should be. Lowering the rate reduces your monthly principal and interest payment.
Break Even “Points”
As a general rule of thumb, it takes approximately 5 years on a 30 year loan to recoup the cost of the points paid provided each point lowers your rate 1/4% as described above. If the drop in rate is not 1/4% for each point paid, the amount of time it takes to recoup the points is longer.
Points are normally a good option if you plan on being in the home for a period of time greater than the time it takes to recoup the costs of the points (break even).
To calculate the break even:
Calculate the Principal and Interest Payment on the Zero Point Loan Calculate the Principal and Interest Payment on the Point Loan Calculate the $ value of the Points Calculate a – b = the savings in your monthly payment Calculate ( d / c) / 12 = the number of years to recoup your points
Here’s an example:
You are purchasing or refinancing your home and borrowing $100,000. Your options are a 30 year loan at 8.00% with 0 points or 7.75% with 1 pt.
To calculate your “break even”:
Monthly principal and interest at 8.00% = $734 Monthly principal and interest at 7.75% = $716 Cost of points paid = $1,000 d) Monthly Savings ($734 – $716) = $18 / mo.
Calculate ($1,000 / $18) / 12 = 4.63 years to break even
There may also be some tax benefit to paying points.
Tax Deductibility of Points – Purchase versus Refinance
When purchasing a home, the points you pay are normally tax deductible in the year you pay them. This may shorten the break even point or number of years it takes to recoup the points considering the savings on your monthly mortgage payment and tax benefit derived.
When refinancing a home, the points you pay are normally amortized over the term of the loan when calculating any tax benefit. For example; paying $1,000 in points on a 15 year loan will give you a $66 tax benefit per year for 15 years ($1,000 / 15).
Always speak to an accountant regarding tax benefits and paying points on a mortgage loan. Your accountant can best advise you based on your particular tax status. Keep in mind, however, if it costs you $100 per month to save $75 in taxes, you are still $25 in the red!
Points and PMI
When the down payment on your loan requires PMI, we normally do not recommend points, however, the decision is purely financial on your part. Paying points may decrease your monthly payment, however, you will have less equity in your home. With less equity in your home, it will take you longer to reach the 20% equity level thereby allowing you to drop the PMI. This is also a consideration if you ever wish to refinance your home.
Do keep in mind the rate of PMI you pay goes down at the following down payment levels:
5% – 9.99% Down – Highest PMI Rate 10% – 14.99% Down – Mid Range PMI Rate 15% – 19.99% Down – Lowest PMI Rate