Get mortgage with zero points or pay points to buy down the rate?


When banks quote loans, they often include several rates with various "points". The term points has multiple meanings in the mortgage world. Mortgage points can refer to loan origination fees (fees charged by the underwriter) or discount points (also known as loan discounts). A point is 1% of the loan amount. Paying discount points allows you to "buy down" your interest rate. Consider points as prepaid interest. The tricky part is trying to identify the best deal among different interest rates and different points.

Points are only a good option if you plan to keep the mortgage long enough to gain from the lower finance charges - as the cumulative savings will eventually cover the additional cost of paying the points upfront - and then some. Often you will find that getting a "zero-point" loan works best for those looking to refinance or sell in a few years.

As a rule of thumb, for a typical 30-year mortgage, each point you pay up front is worth about 1/8 of a percent off your interest rate. Since these points are interest payments, they're usually tax-deductible.

Generally speaking, it takes about five to seven years to recoup the cost of paying a point upfront. Here's the math. Let's say you take out a $100,000 30-year fixed mortgage, and you have the option of either paying 6% with no points or 5 3/4% with one point. With the 6% mortgage, your monthly payment will be $600. And with the 5 3/4% loan, it would be $584, a savings of $16 per month. After about 62 months, or a little over five years, you would have recouped the $1,000 point you paid upfront. And then you would start to benefit from the lower monthly payments.

But you must also consider how you might otherwise invest that $1,000. If you can beat the taxable equivalent of your mortgage rate (about 8% in the example above for those in the 25% tax bracket) then don't bother paying points. Invest the money instead.

This calculator can serve as a guide to compare different loan rates and point options to find the best alternative.

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