Mortgages – Points and Interest Rates Go Hand in Hand

Points vs. Interest Rates: The Connection

What Are Points?

• Definition: Points are upfront fees paid to reduce the interest rate on a mortgage. Each point typically costs 1% of the loan amount. For example, on a $300,000 loan, one point would cost $3,000.

• Purpose: Points effectively lower the interest rate of the mortgage. The more points you pay upfront, the lower your interest rate might be.

Interest Rates

• Definition: The interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. It determines the amount of interest you'll pay over the life of the loan.

• Impact: A lower interest rate means lower monthly payments and less total interest paid over the term of the loan.

Strategic Use of Points and Interest Rates

Long-Term Hold Strategy

1. Paying Points:

   • Benefits: If you plan to stay in your home for a long time, paying points can be beneficial. By paying points upfront, you can secure a lower interest rate, which reduces the total interest paid over the life of the loan.

   • Example: If you pay $6,000 in points to lower your interest rate by 1%, you might save $30,000 to $40,000 over a 30-year loan. The savings from the reduced interest far outweigh the upfront cost.

   • Calculation: To determine if paying points makes sense, calculate the breakeven point—the time it takes for your savings from the lower interest rate to offset the upfront cost of the points.

2. Calculation Example:

   • Loan Amount: $300,000

   • Interest Rate Without Points: 6%

   • Interest Rate With Points: 5%

   • Monthly Payment Without Points: Approximately $1,798

   • Monthly Payment With Points: Approximately $1,610

   • Monthly Savings: $188

   • Points Paid: $6,000

   • Breakeven Point: $6,000 / $188 ≈ 32 months (about 2.7 years)

   If you plan to stay in the home longer than 2.7 years, paying points makes financial sense.

Short-Term Hold Strategy

1. Avoiding Points:

   • Benefits: If you plan to move or refinance within a few years, paying points may not be worthwhile because you won’t have enough time to recoup the cost through savings from a lower interest rate.

   • Example: Opting for a loan with no points might come with a higher interest rate, but the absence of upfront costs aligns better with your short-term plans.

2. Calculation Example:

   • Loan Amount: $300,000

   • Interest Rate Without Points: 6%

   • Interest Rate With Points: 5%

   • Monthly Payment Without Points: Approximately $1,798

   • Monthly Payment With Points: Approximately $1,610

   • Difference in Monthly Payment: $188

   If you plan to sell the home in 3 years, paying $6,000 in points wouldn’t be recouped through the monthly savings.

Negotiating Points and Interest Rates

• Leverage: When discussing mortgage terms with lenders, you can often adjust points and interest rates against each other. For example, you might negotiate a lower interest rate in exchange for paying more points upfront.

• Flexibility: Different lenders may offer various combinations of points and rates, so shopping around and negotiating can help you find the most advantageous deal.

Conclusion

Understanding the connection between points and interest rates allows you to make more informed decisions about your mortgage. Evaluate your plans for how long you intend to stay in the home and your financial situation to decide whether paying points to lower your interest rate is a wise investment. Always consider both short-term and long-term impacts to choose the best mortgage strategy for your needs.