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So you’ve been working on your credit and you finally found a mortgage with a rate and terms you like. Only problem is, when you figure out your monthly payments it still seems a little tight; you’ like to find a way to make your monthly payment a little bit lower to give yourself some breathing room. Or, maybe you just got your GFE and you’re wishing you could find a way to eliminate some of those hefty closing costs. In both cases, the answer you’re looking for could be summed up in one little word: Points.
Most times when buyers and mortgage pros talk about points, they’re talking about a percentage of the mortgage that you pay upfront in order to reduce your monthly payments. Usually, a single point is equal to one percent of the mortgage total (so, for a $300,000 mortgage, one point would be $3,000, two points would be $6,000, etc.). Here’s where it gets a little confusing: Just because you pay points upfront doesn’t mean the total amount of your mortgage will be reduced – in this example, your mortgage will still be $300,000. What it does mean is that your interest rate is slightly reduced for each point you pay. Traditionally, paying a single point reduces your rate by one-quarter of a percentage point. While that’s a general rule of thumb, it can vary by lender and in the recent period of low rates, points tended to be worth less among many lenders – about one-eighth of a percentage point. So in essence, paying points is like paying a small portion of your mortgage interest in advance in order to reduce your monthly payment.
That’s the first type of points – those that you pay upfront. But there are also so-called negative points, which may occur when a buyer decides to pay a slightly higher interest rate in exchange for a credit toward closing costs. Most buyers choose this option when they find closing costs a little too high to handle. The biggest disadvantage here is that paying a higher rate over time – even a slightly higher rate – can add up to a significant increase in the total amount of interest that’s paid. Consider a $200,000 loan at 4.5%. Over a 30-year term, you’d end up paying $164,813.42 in interest. Now say you decide to take a credit toward your closing costs in exchange for an increase in the interest rate to 4.8%. At that rate, after 30 years you would have paid $177,759.06. That’s a difference of $12,945.64. Depending upon the credit you’re receiving and how difficult it would be for you to pay closing costs upfront, you may or may not consider that to be a good deal.
To answer that question, you have to figure out the break-even point – the point at which paying points will actually save you money over the long-term – and that means you have to do some math (sorry!). To make it more complicated, the break-even point will also vary based on the number of points you pay. Fortunately, there are a few calculators out there that can help you out. Generally speaking, the longer you’re going to hold your mortgage, the better off you’ll be paying points. If you plan to sell or refinance your house in, say, five years or less, paying points usually will end up costing you more in the long run. Another way to figure out if it makes sense: Ask your lender. Most have access to tables or calculators that can help you hash things out.
With negative points, it’s a little different. In that case, you need to first determine if you have enough to pay your closing costs – and even if you do, you need to decide if paying them would put you in a financially difficult position – for instance, you’d need to wipe out all your savings and possibly turn to expensive credit cards to pay your bills. If either is the case, you may decide it’s worthwhile to roll the closing costs into the loan.