Should you pay points on a mortgage loan?
What is a point when referring to a mortgage loan? A point is simply a percentage point of the overall loan amount that is paid up front, usually included in closing costs. For example if you are financing $200,000 and paying 1.5 points, you will have to come up with $3,000.
Why pay points toward a mortgage loan? Usually paying points lowers the interest rate you get on the loan. Before paying points you should always calculate if it’s worth the extra cash to get the lower interest rate. A simplified, real world example would go something like this.
A local movie rental business is offering a special promotion on various memberships. Regular movies cost $3.50 to rent per night, but with these new memberships you get special discounted rates. A gold membership costs a one time payment of $100 and it allows you to rent unlimited movies forever for only $1. You could quickly do the math ($100 / $2.50) and find out that it would take you 40 movie rentals before you started seeing real savings but from that point on you would save $2.50 off every movie you rented.
There are many things to consider before taking the deal. What if you only rent 1 movie per month? It would take you over 3 years before you started seeing any savings. What if the movie rental place went out of business? You would wast the one time payment. What if you move far away from the movie rental place? You might have to spend more in gas to get to the movie rental place than you would save from the movie rental deal.
Just with the movie rentals you have to decide how long you expect to stay in your home. If you are only planning on staying a couple of years, it’s probably not worthing paying the extra points. On the other hand if you plan to stay in the home 10 or more years you will probably save money by buying the points and paying the extra up front money.
Here is a great mortgage point calculator that will help you decide if paying the points is worth it for your situation.