What's a Point?
A point, or discount point, equals one percent of a loan amount. For instance, one a mortgage loan of $200,000, one point would equal $2,000.
Why Do People Pay for Points?
Some home buyers pay points to their lender at closing in order to lower their interest rate over the life of a loan. Paying a point on a standard 30-year loan will typically lower the interest rate by .125 percent.
Should I Pay for Points?
Buying points can lower the interest rate of a mortgage loan, but that doesn't automatically make it a good option for every situation. For instance, if you only plan to stay in the home for a couple of years, paying for points probably won't help you.
On the other hand, if you plan to stay in the home (and keep the mortgage) for a long time, paying points could very well save you money.
To find out whether or not points will benefit you, you need to calculate your "break even" point. In other words, you need to run the numbers to see how many months you'll have to stay in the home to make points a wise investment.
To calculate your "break even" point:
1. Figure out what your monthly payment would be without buying points.
2. Figure out what your monthly payment would be if you did buy a point (or points).
3. Subtract the lower payment from the higher to determine your monthly savings.
4. Divide the amount charged for points at closing by the amount you save each month. The number you end up with equals the number of months you must stay in the home (and keep the mortgage) to reach your "break even" point.
Example calculation:
Let's run the numbers for a $200,000 loan for 30 years at a fixed rate.
1. 7% interest rate with no points = $1,330.60 monthly payment
2. Buying 1 point for $2,000 = $1,313.86 monthly payment
3. Monthly savings after the point: $16.74
4. $2,000 / $16.74 = 119 months
In this example, the "break even" point is 119 months, or about 10 years. You would have to stay in the house for 10 years to recoup the cost of the point you paid at closing. If you plan to stay in this house for only three or four years, paying for points would be a bad investment.
Conclusion
A point equals one percent of your loan amount. You can pay points to your lender at closing to lower your interest rate. Paying points may be a wise option if you plan on living in the home for more than a few years. You should always run the numbers to determine whether or not points are a good investment for you.
* Copyright 2006, Brandon Cornett. You may republish this article in its entirety, provided you leave the byline, author's note and website hyperlink intact.
About the Author
Brandon Cornett is the editor of HomeBuyingInstitute.com, one of the Internet's largest and most respected libraries of home buying information -- more than 100 expert articles in 12 different home buying categories! Put this knowledge to use by visiting http://www.HomeBuyingInstitute.com.
tweet this!