What are points, and how much do they cost?
“Points” are really called “Discount Points.” Technically, they’re considered pre-paid interest. Functionally, they buy a lower interest rate on your loan. One point = 1% of the loan amount. Example – 1 point on a loan of $100,000 = $1,000
Should I pay them?
Divide the upfront cost by the monthly savings to determine the break-even period. If you intend to own the property beyond that time, you have the initial basis for a decision. Example – If you pay one point on a $100,000, 30-year loan to discount your rate by 0.25%, you’ll save $15.17 per month. Divide the $1,000 cost by the monthly savings to calculate a break-even point of 65.9 months.
There is, however, more to it than just that.
The rest of the equation – Points can be tax deductible in the year paid on purchase loans and over the life of the loan on refinances (always consult with your tax professional for advice). A lower real cost could shorten the break-even period. Purchase Example – $1,000 paid less 28% tax deduction = net cost of $720 divided by $15.17 per month = break-even period of 47.5 months
The risk – Once points are paid, the money is gone. If you sell or refinance before the break-even point, the difference will be a loss.
Add to your down payment instead. The monthly savings are not as big, but there’s no break-even to reach. Plus, the money still belongs to you (as part of your home’s equity). Example – Borrowing $1,000 less at 5% on a 30-year loan will save $5.37 per month.
Save the money. Cash reserves sometimes prove more valuable than a slightly lower payment.
Bottom Line – Think about whether you are a short-term or long-term owner and then assess whether you are more comfortable with a lower payment, more cash reserves, or more equity. Also consider whether you might refinance at some point prior to breaking even on the cost of any points.
Each option has its own merits and risks. Let us help with your calculations and decisions.
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