"Should You Pay Points To Lower Your Rate?"

Anyone who has shopped for a mortgage loan has faced the question to pay points in order to get a lower interest rate. But a new research shows that for most people paying points turns out to be a bad idea.

For the most part, discount points benefit the lender, not the borrower. I hope you didn't think that lenders were coming up come up with programs and solutions that would benefit you, did you?

What is a point? A point is an up-front payment equal to 1 percent of the loan. Paying one, or two points gets you a lower interest rate thus smaller monthly payment. 

If you hold the mortgage long enough, that saving will make up for the cost of the points. Once the break-even point is passed, you're ahead. But according to a recent study many borrowers don't reach that break-even point and refinance before.

How discount point work:

One lender advertises a 30-year, fixed-rate loan for 5.5 percent and 2 points. If your mortgage is $250,000 After paying $5,000 in points on a $300,000 loan, monthly payments would be $1,419.47.

The bank also had a 6.375 percent loan with no points. The monthly payment with such loan program would be $1,559.67.

If to lower your monthly payment from $1,559.67 to $1,419.47 ($140.20 difference) means you need to pay $5,000, it means that it will take you $5,000 divided by $140.203, it will take you 35 months, so 3 years to recuperate your $5,000, thus it is only beyond that point that you will save money. You will save approximately $45,565 if you keep your mortgage for 30 years. Who keeps a mortgage for 30 years? Hardly anyone anymore.

But it turns out that most people get it wrong. The problem, according to the recent study, is that most homeowners don't keep their mortgages as long as they expect to when they get them, so they don't reach the break-even point. The study looked at 3,785 mortgages granted from 1996 through 2003.

They found that the average homeowner paid off his or her mortgage about three years before reaching the break-even point. Only 1.4 percent of borrowers kept their loans long enough to make paying points worthwhile.

The study also found that borrowers who decided not to pay points almost always made the right decision. Only 1.5 percent of them would have saved money by paying points. It is possible to save by paying them, if you keep the mortgage long enough.

Most people probably focus on how long they expect to keep their home, until they start a family and need more room etc...

But many of these events are not as predictable as we may think. And then there are others big unknown: Will mortgage rates rise or fall after you get your mortgage? Even if you stay in your home as long as you'd expected, if interest rates go down it may be a good idea to refinance your mortgage. If that happens before the break-even date, much of what you'd paid for points may have been wasted.

How stable will your financial situation be in the future?

If you lose your job, or you face any other unfortunate circumstances in life your finances may be affected. Then you may have to refinance to get cash out. Then the lender is the big winner.

What else could you do with that money if you did not pay discount points?

Taking the example above, imagine the extra $5,000 that could be spent on discount points instead was put in an investment account paying 10 percent. Before you consider paying discount points make sure you understand the consequences. It may be better to keep the $5,000 and use it in case an emergency arises. The longer you hold your mortgage term, the more you'll benefit from having a lower rate.

To Your Success,
 

Andre Plessis

Andre Plessis
"The Mortgage Guru"
"A Mortgage Professional whose primary goal is to provide the expertise, guidance and skills necessary to obtain the best mortgage to meet your personal needs".
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P.S. If you are at all intimidated or unsure about the mortgage process if you don’t understand how to evaluate your options in getting a mortgage loan our 24 key questions will help you feel comfortable that you are making the best decisions. Also if you are in the process of refinancing your home with anyone, CALL ME and I will let you know if you are being offered the best loan option based on market conditions and your financial situation.

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