There are two lender fees that can be referred to as “points.” One is the Origination Fee. Technically, this is exactly as it sounds: a fee for originating the loan. The second, called Discount Points, are, in effect, prepaid interest and traditionally paid to obtain a lower interest rate on the loan. Some lenders will quote rates with no Origination Fee and no Discount Points whereas others quote rates with a 1-point Origination Fee that can be reduced to zero at a higher interest rate. So, though they have different names, the result is the same: either can be increased or decreased in order to decrease or increase, respectively, the interest rate.
The decision to pay points to lower your interest rate is, like others, a combination of your expectations and simple math. The first question, of course, is do you have the funds available to pay points? One point is equal to 1 percent of the loan amount. So, using round numbers for simplicity, if you are buying a $300,000 home and putting $30,000 down, one point is equal to one percent of the loan amount or 1% of $270,000 – $2,700.
Points are typically paid in 1/8 (or .125%) increments and the benefit is not always the same. Generally speaking, one point is the equivalent of about 0.25% of interest rate, but the actual pricing is based on the markets and changes from day-to-day; sometimes even multiple times a day.
Simply calculating the time to recoup the cost of paying points through the reduced monthly payment and then measuring that time against your future plans is the typical means of deciding whether or not it is worth it in the long run. For example, let’s say that one point will cost $3000 and the result is an interest rate that nets a monthly payment that is $60 lower than the 0-point rate. Dividing the cost by the monthly savings reveals that the time to recoup the investment is four years and 2 months. So, if your intention is to remain in the home for at least 4 years and 3 months, it will save you money in the long run.
Of course, there are other potential considerations that can influence this decision as well. For example, if there is another investment you can make with that $3000 that will earn you more than $60 per month, it might be in your best interest to use the money in that way. The point is that there is no right answer for everyone, it always comes down to what is best for you, your specific situation, and your financial goals.
As always, I am here to help you obtain the information you need to make informed decisions to achieve those goals. Do not hesitate to contact me at your convenience.