Points are mortgage loan costs typically in association with an interest rate, with one point equal to 1 percent of the loan amount.
So, one point on a $200,000 loan is $2,000. It’s good to pay them, right? Or wait. It’s not good to pay them, right?
The correct answer is “yes.” It is good and it’s not good. So, how do you tell?
Points are often looked upon as prepaid interest, hence the potential tax deductibility. If you paid points last year for your home, you may be entitled to deduct those points from your taxable income before you send more money to Uncle Sam. Note, the tax deductibility can vary for points between purchase and refinance transactions. Points paid during a refinance are usually only deducted over the term of the mortgage. With a purchase, points may be tax deductible for the year paid. (Always consult with a qualified tax accountant.)
If you pay points, you’re paying your lender some of the interest up front, in a single fee, in exchange for a lower rate. What’s the difference in rate if you pay a point? Two points? There is no symbiotic relationship between rates and points, but generally speaking, for each 1/2 point, you can drop your rate by 1/8 percent. Paying one point will drop your rate by a quarter percent, and so on. Again, there is no correspondent tradeoff between points and rates, but usually one point will get you 1/4 percent.
So, how do you decide whether or not to pay points? First, calculate your monthly payments by paying a point. Then, run the same routine with paying no points. Let’s say you’ve got a loan amount of $350,000, and you’re quoted 4.00 percent with zero points. That’s $1,671 per month in principal and interest for a 30-year note. Your lender also may offer a rate reduction of 1/4 percent for one point. The monthly payment on a $350,000 note, at 3.75 percent, drops to $1,621, or a difference of $50 per month.
Now, divide that $50 monthly savings into that point you paid, or $3,500. The result is the number of months it will take to recover the cost of the additional funds to drop your rate. In this case, it would take just more than 70 months, or five years, 10 months, to recover that money. On the other hand, your lender will make an additional $50 per month at the higher rate in lieu of your up-front $3,500.
Make sense? A lot of the decision rides on how long you anticipate keeping the mortgage in question, either by selling the property or refinancing later if rates drop. If you, in fact, don’t anticipate keeping the house for a long time, then paying additional points may not make much sense. Keep in mind, if you do plan on staying in the home for the life of the loan, then that $50 per month savings adds up to $18,000 over 30 years.
It’s really not necessary to rely on outside experts to tell you if paying points is worthwhile or not. Do some of the math yourself, and then determine if paying points is really in your best interest.
John Karadsheh is a licensed REALTOR® with Coldwell Banker, Trails and Paths Premier Properties. He also is an Associate Broker, Accredited Buyers Representative, a Certified Residential Specialist, and was voted in the Top 10 Residential Real Estate Agents in Arizona for 2012 and 2013 by Ranking Arizona, the Best of Arizona Business. You can contact John with any of your real estate questions. Call him at (602) 615-0843, or go to his Web site at www.BuyAndSellAZ.com.