Here’s a quick way to determine if you should pay points when applying for a mortgage.
Step 1: Determine your monthly payment at the interest rate you qualify for without points.
Step 2: Determine the amount of your monthly payment at the lower interest rate if you do pay points.
Step 3: What is the difference in these payments? This is what you would save each month.
Step 4: Divide the cost of points at closing by the monthly amount saved in step 3. This determines the number of months it will take to break even or recover the cost of paying points.
Here’s an example:
Loan Amount – $500,000
Term – 30 Years
- 4.5% interest with no points = monthly payment $2533.43
- Buying 1 point for $5,000 generally can reduce your rate to 4% = monthly payment $2387.08
- Monthly Payment Savings = $146.35
- $5000 / $146.35 = 34.16 months
You will break even in 34.16 months. It will take almost 3 years to recover the cost of buying points to reduce your interest rate and loan expense (This does not take into account TVM calculations). If you plan to own your home well over three years, it might make sense to pay points.