Paying Points On A Loan

Is paying points on  a loan a good idea? When you buy a new home or refinance, it can be a nervous and exciting time. And getting excited and nervous causes people to over analyze and sometimes make poor decisions. Sometimes a client will ask for a lower rate by paying discount points. Each discount point is 1% of the loan amount. This is $1,000 per $100,000 in mortgage. It sounds great to get a rate that is a half percent lower than what you hear about in the news or see online (shopping for rates online is not accurate, see this story for more on that), but what about the costs?

You have to look at the recapture period on points.

Many times points do not make sense for most of us. And the lower rate ends up only being a psychological boost, and not a financial one. It seems we always want to find a deal that is “a little bit better.” If rates are 6%, we want 5.875%, or why not 5%??? But what if rates were 1.75%, would we be angling for 1.5%? Yes! It is human nature. If rates were .5%, we’d ask the lender to give it to us for free.

Below is a typical example to see what paying points gets you:

Loan option #1:

3.625%, 30 Year Fixed Rate
$500,000 purchase price
$400,000 loan amount
2 discount points = $8,000
(each 1 point is 1% of the loan amount)
400k @ 3.625% = $1824/month principal & interest payment

Loan option #2:

4.125%, 30 Year Fixed Rate
$500,000 purchase price
$400,000 loan amount
0 discount points
400k @ 4.125% = $1938/month principal & interest payment

Conclusion

Most people are so happy to focus on the lower rate of 3.625%, they ignore the hard analysis of the 4.125% loan offer. The points for the lower rate are an extra $8,000, but the savings are only $114/month. To spend $8,000 to save $114/month takes 70 months to recapture the cost of the points before you even save any money! That is almost 6 years. And the banks know the average time someone holds a loan is under 5 years. So on average, the banks win on points all the time. Whether people sell their house and move, or refinance, the average mortgage generally won’t be around long enough for points to pay off.

The question should simply be one of recapture period. What am I spending, and what am I saving? So, should you spend $8,000 to save $114/month? For most of us, who seem to refinance or move before 5 years comes and goes, I’d think the higher rate is the better deal. The answer for each of us as individuals lies in doing our own analysis.