getting points on a loan

2 Replies

When you get points on a loan what you are essentially doing is just paying interest in order to get a lower interest rate and not actually putting money into the house, correct? To me it would seem dumb to do this because you could be getting equity in the house but instead you are just paying down on interest you will be paying anyways. Is this the right way to think about it or am I backwards and by lowering points you overall lower the amount you will end up paying for the house.

@Mike Troyke I guess I would phrase it not as you are "getting points", but you are paying points. That is exactly what you are doing. One point being 1% of the loan amount. This is not you paying interest - it is simply, straight up, a fee that you are paying for the lender to give you a lower interest rate. 

Basically, banks determine what the lowest rate they are able to offer without points. In order to drop the rate lower, you pay X amount in points. 

Often it does not make sense. A lender should help you do a break-even analysis. 30 Year Fixed pricing doesn't usually lend itself to a solid break-even on paying points, unless you will hold the mortgage for a very long time - 15 years or longer. But sometimes the break-even on a point scenario works out. ARMs can present smaller gaps between each .125% of interest rate, compared to a 30 Year Fixed. Let's say you wanted to do a 7/1 ARM and pay 1 point. Let's say your rate will dip by .50%, your monthly savings is $150/month, and the total cost in points was $4,000, you would take the $4,000 in points, divided by $150 in monthly savings, that gives you a 26 month break-even. If you happened to stay in the property for the full amount of fixed ARM years (7 years), your savings over the seven years is roughly $8,700.

That is a very simplistic view of the analysis that should be done. You could also take into account time value of money to really determine whether or not it was worth it. I would agree for the vast majority of clients, paying points does not make sense.