The issue of paying points on
your mortgage is one that every borrower, first-timers
and veterans alike, is going to have to deal with. Paying points has its pros
and cons (as do so many things in the world of mortgage), but the circumstances
of a refinance
may make paying points a much worse idea.
What are Points?
A point is worth 1% of the principal of your
mortgage. If your loan has a $250,000 principal, one point would be $2,500, two
points would be $5,000, and so on.
One pays points at the beginning of a
new mortgage in order to lower the overall interest rate. The money, rather than
going to pay off the principal (like a down payment), is incentive for the
lender to lower the interest rate, making your loan total and monthly payments
Did You Know? Points are not tax-deductible as a lump
sum; the write-off will be amortized over the period of your loan. Keep this in
mind when deciding whether or not to pay them.
How Does Refinancing Affect My Decision?
In order for paying
points to be financially worthwhile for you, you need to keep your loan long
enough for the savings on interest to exceed the up-front cost of paying the
points. For example, if you pay two points on that $250,000 mortgage, you should
have saved $5,000 in monthly
by the time you refinance again, sell the house, or pay everything
Generally, borrowers don't stick with their refinanced
loans long enough to make paying points worthwhile. Since you aren’t paying down
principal when you pay points, you aren’t building any equity. That means you'll
only see the benefit years down the line when you’ve paid enough of your loan
off that some savings occur. Unfortunately, statistically, you are more likely
to have refinanced or sold your home by then.
To avoid this, calculate
the break-even period. This will show you how long you need to make payments on
your loan until your savings on interest equal what you paid up-front. Once you
find out what your lender is offering in terms of a rate reduction, you can
calculate how long it would take to make paying the points worthwhile. Then, you
can make a decision based on where you see yourself at the break-even
The basic rule of thumb is this: if you decide to pay points up
front, you should be very confident that you will be making payments on this
particular mortgage for a while. It is quite common for borrowers to end up
paying more in the long run because they didn't inspect the break-even period
closely enough. However, if you plan on staying in this house with this mortgage
for a long time (and you have some extra cash up front), paying points might be
the right decision for you.