Points Vs. Mortgage Interest Calculation

The use of points gives flexibility to mortgage rates and terms.
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After talking to a mortgage lender, you now have some choices to make. Is it better to pay points and get a lower rate or should you keep your cash and choose to secure a mortgage with no points and higher interest rate? Paying points is sometimes called "buying down" the rate. Gather your facts, figures and mortgage payment calculator to determine which path makes the most sense for you.

Points and Rates

A point is 1 percent of the loan amount. Discount points are the cost to buy a mortgage down to a lower interest rate. For example, your mortgage guy quotes the current mortgage rate at 5 percent. He also tells you that you can pay 2 points and buy the rate down to 4.5 percent. On a $200,000 loan, the cost to get the lower rate would be $4,000. Your lender might offer a range of possible loan rates with corresponding discount point costs to get a loan at those rates.

Calculate Mortgage Payments

To determine whether buying down your mortgage rate makes financial sense, you need the payment amounts for the two different rates. Use an online mortgage calculator or just ask the loan officer to calculate the payments. To illustrate with the ongoing example, a $200,000, 30-year mortgage at 5 percent has a loan payment of $1,073.64. At 4.5 percent, the payment will be $1013.37. In this case buying down the rate saves $60.27 per month on the payment

Payback Period

Divide the cost of the discount points by the monthly payment savings to find out how long it takes to earn back the cost of the points. In the example, $4,000 divided by $60.27 means that it will 66 months or 5 1/2 years to recover the cost of the points at the lower rate. If you keep the home and the loan longer, buying down the mortgage makes sense. If you end up selling or refinancing the loan in less than the payback period, you did not get the full benefit of buying down your mortgage rate.

Qualifying Payment

An alternative reason to buy down a mortgage rate is to get the lower payment for loan qualification. Lenders use debt-to-income ratio guidelines that set a limit for a house payment based on your income. If the regular mortgage rate the payment puts you just over the ratio, paying points to lower your rate and payment could let you qualify for the loan.

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