What are Points & Should I Pay Them

Discount points often referred to as “points,” are one-time fees paid at closing to reduce the overall interest rate of a loan. This may provide greater benefits to the borrower over the life of their loan in terms of interest paid. Points are generally calculated as a percentage of the total loan amount, and may be equivalent to 1% – 2% or even more depending on the situation. The main thing to understand about interest rates are that they are a function of cost, so if a borrower is willing to pay more fees up front at closing you can usually obtain a lower interest rate.

Deciding whether to pay points or not can be one of the most difficult decisions for a consumer when buying or refinancing their homes. For most of us the initial thought process is, “why would I want to pay extra fees when I don’t have too?” In order to answer that question a borrower must determine how long they expect to be in that particular loan for. Once that question has been answered the next step is to perform a break-even analysis.

Break Even Analysis: 

  1. Determine the cost of the points. Example: 2 points on a $100,000 = $2,000.
  2. Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Example: $50 per month
  3. Divide the cost of the points by the monthly savings to come up with the number of months to break even. In the above example, ($2,000 / $50 per month = 40 month) to break even. If the borrower in this example plans to stay in this loan longer than the break-even point, then it makes sense to pay points; otherwise it does not.

A general rule of thumb: If you plan to stay in your home for less than three years, do not pay points, more than five years pay points, and  between three and five years it does not make a significant difference whether you pay points or not.

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