Points on a loan are the dollars paid as a percent of the loan. Points are commonly used to lower the interest rate. Paying for one or more points at closing may also reduce monthly payments. Is paying points for discounts on interest rates worth it? It depends on several factors.
One point represents 1% of the loan. For a $350,000 loan a point would cost $3,500. Basically, you are paying for interest ahead of time in return for lowering your interest rate for the duration of the loan. Lenders interest discounts may be different like .75% instead of a whole 1%. Be sure to check with your lender.
Is paying points worthwhile? A good rule of thumb is, the more years you stay in your home, the more you will benefit from paying for points. Here’s a loan example (sample figures provided, actual figures depend on individual lender and loan program):
Loan Amount: $350,000
Cost Per Point: $3,500
Interest Rate Reduction: .75%
| 0 Points | 1 Point | 2 Points | |
|---|---|---|---|
| Cost per Point(s) | $0 | $3,500 | $7,000 |
| Interest Rate | 6.125% | 5.375% | 4.625% |
| Monthly Payment (Principal and Interest) | $2,126.64 | $1,959.90 | $1,799.49 |
| Monthly Interest Savings | $0.00 | $166.74 | $327.15 |
| Break Even (Time to Recover Points Cost) | N/A | 21 Months | 21 Months |
For a $350,000 loan, each point costs $3,500. The lender offers you an interest rate reduction of .75%. Your interest rate of 6.125% will lower to 5.375%. That will cut the $2,126.64 monthly payment to $1,959.90, saving $166.74 every month. In 21 months you’ll break even on what you spent for 1point.
By paying 2 points, your interest rate of 6.125% will lower to 4.625%. That will cut the $2,126.64 monthly payment to $1,799.49, saving $327.15 every month. In 21 months you’ll break even on what you spent for 2 points.
Purchasing points makes a lot of sense when:
- You have a fixed rate mortgage loan.
- You’ll still live in the home after breaking even on the cost.
- Your monthly interest savings will not be offset by a monthly payment of private mortgage insurance (PMI)
Points Can Be Tax Deductible
You may be able to deduct the money spent on points as part of your mortgage interest deduction. Points need to be listed on the tax return during the same year that they were paid and must be applied to the home you live in. Check the IRS website for more details.
Compare 20% Down Payment To Buying Points
If you make a 20% down payment, it saves you the extra cost of PMI or private mortgage insurance. Run the numbers to see if the savings from PMI are greater then the savings from lowered interest rates and reduced monthly payments.
