To pay points or not to pay points, that is the question! In today’s article we discuss what points are, and if you should pay them or not. The one thing I have not been able to find out, it why they are called “points” in the first place.
In simple terms, paying points will get you a lower interest rate on your mortgage loan than a loan with no points being charged. As lenders, we all try and offer the borrower options. Take a higher rate, and get a credit from the lender to offset some of your closing costs (that’s what happens for those loans advertised as a no-cost loan). Or get a loan with zero points – neither a cost nor a credit. Or pay some amount of points to bring the rate down. For some with lower credit scores and having smaller down payments, there may not be a higher rate offered, and paying points may be the only option.
The decision to pay points comes down to one important factor: How long will I keep this loan?
When I speak to new clients buying a home, they are always taken aback when I ask them this question. Most of them have never really given it any thought. All that was on their mind was to buy the place, and not necessarily how long they will own it, or in a sub context, how long they will keep the loan they used to finance the purchase. For some, this purchase may be a starter home – one in which they will live for 5 or so years, then move to something bigger, when the first child arrives. For others, it may be an investment condo – those too, only seem to be owned for 8 years or less.
It is important to differentiate between how long you will own the property, with how long you plan on keeping the loan you are getting. If the mortgage you are obtaining has life-of-loan mortgage insurance, like FHA loans, you may be keeping the home until you die, but in order to get rid of the MI, you would need to refinance at some point. Or maybe the situation is one in which you own another property and at some point you will sell that and pay off or substantially pay down the mortgage you are obtaining for this transaction. Or it could be as simple as refinancing in the future to pull out equity for their kid’s college expenses.
Whatever the case is, knowing how long you plan to hold the loan you are applying for is the first important piece of the puzzle to determine if you should pay for points or not. Once you have your answer, the rest of it is just math.
Here is a sample of a points analysis worksheet I gave to my clients this week.
If they chose the 4.875% rate, they would receive a credit of $1,750 towards offsetting their other escrow and title fees.
If they chose the 4.750% rate, they would pay 0.125 points, or $875. By paying the points, their rate drops by $52.93 per month. If they chose this rate versus the 4.875% rate, it would take them just under 50 months to recapture the cost of the points with the lower monthly payment. The recapture time is calculated by adding the credit of $1,750 and the cost of $875 ($2,625) then diving by the monthly lower payment savings ($2,625 ÷ $52.36 = 49.60)
Pay close attention to the cost of the points and its corresponding rate. You will notice that for every 1/8th percent in rate you drop, the cost of the points does not go up uniformly. There’s only a difference of 0.375 points between 4.875% and 4.750%, but there’s a difference of 0.750 points between 4.500% and 4.375%.
You should expect a detailed discussion and points analysis from your mortgage originator. It is not for you to bring up either. If they aren’t asking you the pertinent questions and providing you something like what is above, maybe you are with the wrong lender.
One final thought on points. There’s a huge difference between “Discount Points” and “Origination Points”. Discount points are the ones you pay to get a discounted (lower) rate. Origination points are a bygone scam way for lenders to confuse a borrower into giving them more money without any benefit. Don’t ever pay Origination Points.