Mortgage Points - To Pay or Not to Pay?

By Steve Gillman - 2008

Mortgage points. Should you pay or not? There are many home loans out there that have no points, so you do have the option, but as you probably know, you'll pay higher interest on such loans. How do you determine which way to go?

To begin with, let's look at what a point is. Essentially it is a loan fee, another way for the lender to make money on a loan. These are sometimes also called discount points, because you pay them to get a discounted interest rate. Another way it is expressed is that you "buy down" the interest rate by paying points. But the simplest definition is that a point is one percent of the loan value. Thus, for example, two points on a $300,000 loan would be two percent, or $6,000.

Pay the Points or Not?

Whether you should pay the points or not depends on your job, or rather on your job, your interests and all the things that predict where you'll be in the future. You see, the points are paid up front, while your savings from the lower interest rate are spread out into the future. You'll get more benefit if you own your home longer, or don't refinance for more years.

Let's look at an example. If you were to borrow $250,000, without points, at 6% on a 30-year mortgage, your payment would be $1,499 per month. On the other hand, if you paid two points, or $5,000, to get the interest rate down to 5.5%, your payment on the $255,000 (points are often added on to the loan), would be $1,448 per month. That's a savings of $51 per month.

Is that worth it? The simple calculation is that it will take almost eight years to save the $5,000 you paid in points, so if you'll be keeping the mortgage loan for longer than that it might be worth it. Of course, it is more complicated than that if you want it to be. $5,000 now is worth more than $5,000 spread out over eight years after all. If you invested $5,000, for example, and used it each month to pay the extra $51, it would certainly last more than eight years.

You should probably avoid the complex computations though. A rough guide is enough given how unpredictable life is in any case. Just do the quick figuring and ask if you are likely to keep the loan for eight years - or whatever length of time it takes to repay the cost of the points in your case. Think not only about whether you'll be moving, but also whether it is likely that you'll be refinancing within that time frame. If either is likely, skip the points.

Mortgage Points - A Special Case

There is one circumstance when you should pay the mortgage points without regard to how long you'll keep the loan. This is when your offer on a home has a clause that makes the seller pay closing costs, and those costs include loan points. You have to get some estimates and do a little math for this, but it is worth it.

For example, suppose the offer states, "seller to pay up to $5,000 of buyers closing costs, including mortgage points." What you need first, is to determine what non-loan costs the seller will be paying. Suppose these add up to $2,000. If you were borrowing $200,000, then you would want to "buy down" the interest rate - but only by as much as 1.5 points will get you. The $3,000 these mortgage points would cost would be paid by the seller at closing, along with the other costs. If you didn't pay points, you would be giving the seller a $3,000 break.

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