Mortgage Points Explained and When it Makes Sense to Buy the Rate Down

Often when I talk to people they start the conversation with “I do not want to pay points.” This is a red flag to me that we need to talk about points.  Points are very misunderstood and when utilized correctly they can give you a huge advantage in terms of both your monthly payment and how much you pay in interest over the life of the loan.  The main cause of confusion is that there are two different types of points. There are mortgage origination points which are a fee paid to the loan originator and discount points.  It is odd to see actual origination points anymore but back in the hey day of naughty lending there were a lot of people fleecing clients with excessive mortgage origination points and that is why so many people think points are bad.

Discount points are entirely different. A discount point is a measurement of cost to get a lower than market rate.  If the market is at 4.5 you will have the opportunity to buy a lower rate via discount points.  1 point = 1% of the loan amount.  1 point does not move the interest rate 1%. 1 point may move the rate down .25% or 1.25% or .375%, it all depends on the day and where the market is.  In order to determine if it makes sense to buy the rate down you need to have a pretty good idea how long you want to keep the property.  On every loan I have ever done for myself I have bought the rate down using discount points.  In my case the houses I have bought I want to keep forever.  I know that they will provide consistent rental income and I see them as part of my retirement strategy so trying to get the lowest rate makes sense for me.  If you only see a home as a starter house that you will live in for two years, buying points generally does not make sense.

 

Every scenario is unique and if you are considering points there is a simple way to figure out if it makes sense for you.  Below is the math and a few examples.

 

THE MATH:

Take the cost of the buydown divided by the payment difference of the rates divided by 12 = how many years you need to stay in the home for the buy down to make sense.

Example

200,000 Loan

4.5% no points: Principal and interest payment=$1013

4.25% with a .5pt cost: Principal and interest payment =$983

.5pt in this example is $1000 so the cost to get the lower rate is $1000

Payment difference between rates = $1013-$983= $30

$1000 divided by $30 divided by 12 = 2.78

You would need to live in the house for over 2.78 years for it to make sense to buy the rate down.

 

Example 2

$900,000 Loan

4.5% no points: Principal and interest payment=$4560

4% with a 1pt cost: Principal and interest payment =$4296

1pt in this example is $9000 so the cost to get the lower rate is $9000

Payment difference between rates = $4560-$4296= $264

$9000 divided by $264 divided by 12 = 2.84

You would need to live in the house for over 2.84 years for it to make sense to buy the rate down

 

Example 3

80,000 Loan

4.5% no points: Principal and interest payment=$405

4.375% with a 1pt cost: Principal and interest payment =$399

1pt in this example is $800 so the cost to get the lower rate is $800

Payment difference between rates = $405-$399= $6

$800 divided by $6 divided by 12 = 11.11

You would need to live in the house for over 11.11 years for it to make sense to buy the rate down

 

I hope this has helped you!  If you have questions, give me a call at 707-478-0637

All My Best,

Jen

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