Should You Buy Mortgage Points?
One of the choices buyers are faced with when financing their home is the decision to take out a loan with points. This mortgage points calculator can be used to help determine if buying points is worth the upfront investment. The calculator requires a total of five inputs:
- The home loan amount, which is the sum of money borrowed to finance the home’s purchase
- The annual interest rate of the loan if you decide not to pay points
- The term of the loan, which is the number of years over which the mortgage will be repaid
- The annual interest rate of the loan if you decide to pay points
- The number of points paid
The calculator then provides the user with three sets of values:
- For the no points scenarios, the calculator provides the monthly payment, total of all payments, and the total interest charges paid on the loan
- The calculator provides the same set of information for a scenario involving a mortgage with points
- Finally, the calculator provides the cost of points, which is the upfront payment to secure the loan, how much money is saved each month by paying points, and the number of months required to recover the cost of the points
What are Mortgage Points?
When we repay a loan of any type, including a mortgage, the amount we repay falls into two categories. First, we are repaying the principal of the loan, which is the money we borrowed. We are also paying a finance charge, which is the cost of borrowing this money. This finance charge is usually stated in terms of an interest rate. Typically, lenders quote two interest rates:
- The actual rate of interest charged on the outstanding principal
- Annual Percentage Rate, or APR, which can be used to compare loans since this rate includes all the fees associated with the loan such as processing charges and origination fees. Since the APR includes all the costs associated with the loan, it will always be higher than the rate of interest charged on the outstanding principal
Interest Rates and Risk
One of the factors that determines the interest rate a lender will charge on a loan is the risk of non-payment. That is why borrowers with higher credit scores are oftentimes offered loans with lower rates of interest than borrowers with lower credit scores. Offering loans with points is one of the other ways a lender can reduce the risk of non-payment. When a borrower pays points, they are “prepaying” a portion of the finance charge, which reduces the lender’s risk. That is why loans with points will always feature a lower rate of interest than a loan with zero points.
Is Paying Points a Good Idea?
In exchange for this upfront payment of points, the borrower enjoys lower monthly payments (since the interest rate charged on the loan will be lower). To understand if it’s a good idea to pay points, we need to understand how long it takes to recover the upfront payment of points. For example, if the borrower buys points for 2,000 and they save 50 per month, then it will take 2,000 / 50, or 40 months to recover the cost of the points they paid. If the borrower intends on moving in 24 months, then they would have only saved 50 x 24, or 1,200 by paying points. In this example, they are worse off by 2,000 – 1,200, or 800, and would have been better off with the no points loan.