Should Homebuyers Pay Points to the Bank When Securing a Mortgage?
A typical mortgage seeker for a home purchase has many decisions to make during the process. One of the important ones is whether or not to “pay points,” or as it is alternately referred to as, “buying-down” the rate.
In addition to the normal fees the bank charges mortgage seekers (appraisal, underwriting, credit reports, etc.), the buyer will need to decide if it is financially feasible (and smart) for him to pay an additional amount, or points, in order to lower his monthly mortgage payments. Borrowers typically can pay anywhere from 0 to 3 or 4 points.
Each point is exactly one percent of the amount of the loan (for example, a point on a $100,000 loan would be $1,000).
Lending banks often offer a homebuyer a couple of options when seeking a standard 30-year fixed loan. Let’s take as an example a loan/mortgage of $325,000.
- Pay zero points at today’s rates, and the interest rate would be about 4.25%.
- Pay one point (one percent of the loan or $3,250) up front to the bank and your interest rate would probably drop to 4%. Paying the point at closing to lower your rate by .25% reduces your payment $42 per month and lowers your interest cost $68 per month.
So, does it make good economic sense to pay points to the bank?
The answer to the question is contingent upon how long you plan to live in your new home and what the total savings would be during that timeframe. Matt Weaver, vice president of sales at Finance of America Mortgage informs us that there is a simple formula to arrive at the proper answer for each individual homebuyer: “We can calculate this by taking the dollar value of the point (or buy-down) and dividing it by the monthly savings from the lower interest rate – then divide that figure by 12 months.”
Weaver provides an example to help conceptualize this: If a prospective homebuyer will need to pay $2,000 in a buy-down to generate $30.00 per month in savings, we should divide $2,000 by $30.00. The result would be that it would take 66.7 months (or five and a half years) to recoup that initial buy-down of $2,000.
So, the answer to the question is now easy. If you’re relatively sure that you will remain in your new home for a minimum of five and a half years, then definitely take the buy-down. The only other point to take into careful consideration is how much savings you will still have after the closing – can you afford to pay the points without dangerously squeezing your finances?
In essence, buy-downs are actually pre-paid interest on the mortgage loan. The more points you pay, the lower the interest rate on the loan and vice versa.
Finally, mortgage seekers should also be aware that paying points is tax-deductible.