Should I Pay Points on a Mortgage?
The question of whether to pay points on a mortgage can be a complex one, with numerous factors to consider. A point is defined as 1% of the mortgage amount, serving as a fee charged by your lender. This article aims to guide you through the decision-making process by examining the pros and cons of paying points.
Understanding Points
Mortgage points are optional fees that homeowners can pay in exchange for a lower interest rate. Essentially, you are paying a lump sum at the time of closing to reduce the cost of borrowing over the life of the loan. This is a financial trade-off that requires careful consideration.
When to Pay Points
The decision to pay points depends on several factors, primarily your intended length of ownership. Here are some key points to consider:
Break-Even Point
A calculator can help you determine the break-even point, which is the number of months necessary for the savings from paying points to outweigh the upfront cost. Use a mortgage calculator to compare the monthly payment amounts for a no-points rate and a rate with points applied. Subtract the lower payment from the higher payment to determine the monthly savings, then divide this amount by the cost of the points. The result is the break-even point in months.
Long-Term Versus Short-Term Ownership
If you plan to keep your mortgage loan for a longer period, it may be financially beneficial to pay points. Conversely, if you expect to sell the home or refinance within a shorter timeframe, paying points may not be advantageous.
Alternative Investments
Consider whether the funds you would use to pay points could generate a higher return elsewhere. For instance, if your money is currently in a high-yield investment like a 401K, paying points may not be the optimal choice. However, if you incline towards spending the money rather than investing it, paying points could provide lower monthly payments and additional funds to spending.
Discount Points and Savings
Paying discount points can lead to a lower interest rate, potentially saving you a significant amount of money over the life of the loan. For example, one point may offer an 1/8th reduction in your interest rate. It is advisable to inquire with your lender about the specific discount offered for your particular loan.
Conclusion
In general, paying points can be a wise choice for those planning to remain in their home for a extended period. However, for those foreseeing a shorter ownership, it may not be the most economical option. Always perform a thorough cost-benefit analysis and consider personal financial goals before making a decision.
Key Points:
Points are fees charged by lenders in exchange for a lower interest rate. The break-even point is the number of months when the savings from paying points equal the initial cost. Consider alternative investments and personal spending habits when deciding whether to pay points. Paying points can be beneficial for long-term ownership due to potential savings over the life of the loan. Short-term ownership may not justify the cost of paying points.