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How to Calculate When Paying Points on a Mortgage is a Wise Financial Decision

By on March 27, 2012 in Mortgage

How to Calculate When Paying Points on a Mortgage is a Wise Financial DecisionMortgage interest rates are sitting at or near historical lows. Rates are so low that you can almost get a better interest rate on a savings account than you can on a mortgage.

In this low interest rate environment getting a mortgage requires great finances. If you’ve got your financial house in order you will be given the best rates around. As with any mortgage or refinance you have the option to pay additional points to the loan originator to receive an even lower rate. Does it ever make sense to do this or are you best off taking the rate that’s given to you based on your credit rating?

Should You Pay Points on a Mortgage?

Whether or not paying points on your mortgage is a good decision depends on how much the points cost you and how much of a rate drop you receive on your mortgage interest rate. If you are looking at paying thousands of dollars for a 0.25% drop, it probably doesn’t make sense. However, the only way to truly know is to compare your options.

How to Compare Two Mortgages

There are a few simple steps you can take to decide whether or not you should pay points for a lower interest rate. For example, let’s say you can get a $160,000 mortgage at 3.75% for 30 years with no points or 3.675% for 30 years paying $1,500 in points. Which mortgage should you take?

Compare Total Interest

First, compare the total interest of the two mortgages. You can use a mortgage interest calculator to do this. The no-points mortgage will cost you $106,755 in total interest over the 30-year life of the loan. The mortgage with points paid drops the total interest cost to $104,309.

The difference between the two mortgages is $2,446 which makes paying points look like a good move.

Add Points Paid To Total Interest

Before you pull the trigger on the mortgage with points, you need to stop and add the points cost into your total interest calculations. The mortgage with points will cost you $104,309 in interest, but the true cost of the mortgage also includes the $1,500 you are paying out of pocket to get the lower interest rate.

Your total mortgage cost jumps to $105,809. That means the total cost difference to you is about $946 over the life of the loan. Still a positive move, but is it worth it?

The Time Value of Money

This is where the concept of the time value of money applies. You can pay $1,500 today to save a total of $946 above that cost over the life of the loan. On a 30 year loan that is only saving $31.53 per month. While not insignificant, would that $1,500 be better spent elsewhere?

If you have the money available then by all means, get the lower interest rate and make the positive financial move. However, be sure to look at where else that $1,500 could be spent: as part of a home maintenance fund for the inevitable problems that occur with home ownership or in your emergency fund. You could always pay a little bit of extra money on the mortgage out of that $1,500 as well which would help lower your total interest costs without fully committing you to dropping the full amount into the mortgage.

Before you make a decision on paying points on a mortgage, run the numbers to see if it is money well spent.

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