To Pay or Not to Pay: All About Points
You see the ads all the time, whether on television or the internet: “Zero Point Loans,” or “No Closing Costs Loans.” Why would you ever consider paying points for a loan program? Please, read on.
First of all, the old adage applies, “You get what you pay for.” “Zero Point” loans and “No Closing Costs” loans aren’t truly “Zero” or “No Cost.” The up front costs are merely added to your interest rate or absorbed by your mortgage or loan balance. It’s that simple.
This may sound unfair, but the truth is that no one works for free, and lenders do not lend for free, either. The loan examples in this article use arbitrary numbers, but they illustrate factual principles. Once you understand them, you can weigh your priorities when acquiring a loan and act accordingly. Understanding what points really are is crucial. It gives you some measure of control when deciding which loan program meets your needs, and how much you are willing to pay to have those needs met. It also protects you from exploitation. Please, keep reading and, we promise, you’ll thank us later.
Whether you are acquiring a new home loan or refinancing an existing mortgage, a mortgage company usually offers a range of interest rates for varying amounts of points. A point equals one percent of the loan amount. For example, three points on a $100,000.00 mortgage loan would add $3,000.00 to the financing charges or closing costs. Analyzing various interest rates and associated points is a good way to save money. As a rule of thumb, each point adds about one eighth to one quarter of one percent to the interest rate the lender is offering. Generally, the lower the interest rate on the loan, the more points the lending institution will charge. Some companies offer financing with “No Points,” but generally charge much higher interest rates. Why? Because the points are directly added to your interest rate. It is up to you to choose which rate truly meets your monthly financial needs, and which rate you can afford. To decide what combination of rate and points is best for you, balance the amount you can pay up front to acquire the loan along with the amount you can afford to pay for your monthly mortgage.
The less time that you keep the loan, the more expensive points become. If you plan to stay in your house for a long time, then it may very well be worthwhile to pay additional points to obtain a lower interest rate. If you plan to keep the house or loan for only a short period of time, a so-called “Zero” points loan is probably the better option. Let’s break this down. As an example, let’s say you are buying a $400,000.00 house, using 20% cash for a down payment. You will be financing the additional $320,000.00. You could pay two points for a 6%, 30 year fixed rate mortgage (a cost to you of $6,400.00) and have a monthly payment of $1,918.56. Or, you can save the money you’d pay for points, acquire an 8%, 30 year fixed rate mortgage (at so-called no cost), and pay a monthly mortgage payment of $2,348.05.
Though you paid $6,400.00 in points, the 6% rate saves you $429.49 a month, and will pay for itself in savings in a little over a year. Let’s take this scenario one step further by comparing the interest that would be paid over the life of both loans. $320,000.00 at 6% rate for 30 years: $370,682.20 $320,000.00 at 8% rate for 30 years: $525,296.79 The net full-term savings of the 6% rate: $154,614.59 Suddenly, paying $6,400.00 upfront for long-term savings doesn’t sound too bad, does it? Definitely something to consider when deciding whether to pay points, or not. Some companies may offer to finance the points so that you do not have to pay them upfront. Please bear in mind that this means the points will be added to your loan balance, and you will pay a finance charge on them. Although this may enable you to get the financing, it also will increase the amount of your monthly payments.
In Summary:
Paying points for a lower interest rate truly is a trade off between paying money now versus paying money later. A point – equaling 1% of the total loan amount – is an upfront fee that reduces your interest rate and the total interest paid over the life of your loan.
You need to clearly define your priorities when choosing a loan: Are you payment driven, hoping for the lowest payment possible? Or, are you more interested in conserving immediate out of pocket costs? These are the deciding factors for both the loan program choice, and the final loan costs. In other words, your priorities will determine whether “To Pay or Not to Pay” points for your loan. Your Real Estate Agent, Financial Adviser, and — of course — a quality Loan Consultant can also advise you as to what’s best for your specific financial needs. Please feel free to call us. We’re always happy to assist you.
