Mortgage points simplified

As you plan for the future you may find that a lower mortgage payment would provide more financial security.  One way to achieve this is to purchase points. For many people, determining the cost or savings of mortgage points on a loan may seem like complicated business but understanding when to buy them is really quite simple. 

Mortgage points are also known as discount points.  Points are the lump sum cost of the loan and are paid upfront to the lender at a specific rate, typically 0.125 percent.   Points are also a type of pre-paid interest that can help get a lower interest rate on the mortgage loan.  Each point is equal to one percent of the principal loan amount.  Typically lenders offer point purchases of one-to-three percent of the principal loan amount. For example, the principal amount of the mortgage loan is $100,000 making the cost of the point at one percent equal to $1,000.  ($100,000 x 1% = $1,000). 

Purchasing points makes sense when you can afford the upfront cost and intend on owning the home for several years.  Be aware, there is a break-even point.  Follow this example to determine your break-even point:

·         $100,000 loan, 30 year term

·         7% interest with no points = $665.30 monthly payment

·         Buying one point for $1,000 for a 6.875% interest reduces the monthly payment to $656.93

·         Monthly savings ($665.30 – $656.93) = $8.37

·         Months to break even ($1000 / $8.37) = 120 months

The break-even point is 120 months—or ten years to recover the cost of buying the discount point.  So if you plan on staying in the house for at least 10 years it purchasing a point would save you money. The longer you stay in the home, the more money you will save.

You can also use a mortgage point calculator to determine how many years it would take to break even and run various down payment and interest rate scenarios. 

Bottom line, the longer you hold the loan the more attractive it becomes to purchase points. In the scenario above if you purchased one point for $1,000 and stayed in the home for 15 years you will have saved $506.60 ((8.37 * 180 months) – $1,000 used to purchase point).  In addition, if you put the monthly savings of $8.37 into an interest bearing account you could have $1,755.30 at the end of the 15 years (assuming a 2% interest rate compounded monthly).

Resource; Bankrate.com