Should you pay points?

Regardless of whether you are buying a home or refinancing an existing mortgage and whether you are using a broker or going directly to the bank; you have a choice when it comes to paying points. The cost of a point is one percent of your loan amount and is added to your closing costs. For a long time “points” have had a negative connotation amongst the general public. So, first time buyers in San Diego, looking to take their first step towards a now affordable home purchase may be confused on what to do. But, the truth is, points directly affect the interest rate on your mortgage. The higher in rate you go, the lower the points and the opposite applies.

So, a lower closing cost scenario can end up costing you more in the long run as a result of a higher interest rate. In today’s market, where a home is once again a long term investment and with the 30 year fixed rate as low as it is, paying a point to get the lower rate can makes sense.

When you are deciding what makes the most sense it's all about “recouping”. How will the point or cost affect the rate and how much will be saved over the long term? In short, how quickly can the fee be recouped from the savings of the lower rate? Using today’s rate as an example, let’s see:

Today the 30 year fixed with no points is at 5.625%. But by paying one point we can get the interest rate down to 5.25%. If we took a $300,000 loan amount 1 point is equal to $3000. Now let’s look at the difference between the two rates. A $300,000 loan at 5.625% will equal a payment of $1727 a month. If we paid the point and got the rate down to 5.25% it lowers the payment to $1657. So for a $3000 investment we will save $70 a month. Then divide that savings, ($70) by the cost to get it ($3000) and we get 42 months. In just 3.5 years we will have recouped that point in our monthly savings. Obviously if you are planning on staying in the home for over 3.5 years then the savings is worth the investment. (It’s also unlikely that you will refinance the mortgage within 3.5 years.)

There can be many different options to fit your closing costs and interest rate needs. You can pay just a half a point or pay more; buy down the rate further with 2 points. Always ask your loan officer for the rate with and without points and have him/her show you how quickly you will recoup that fee. As a general rule of thumb if you can recoup the cost within 3-4 years it’s probably worth it, depending on your long term plans with the home. (Be warned however of loan officers that offer “no points” and then charge 1% origination. One percent is a point regardless whether it is called “origination” or a “point”.)