Is There Any Benefitto Paying Points on Your Home Loan?
by Terrie J. Burd
If you don’t understand the concept of points, you are visiting the right place. In simple terms, points are paid by a borrower to a lender to reduce the rate on a mortgage. A point represents 1% of the face value of the mortgage. If, for example, you pay one point on a $100,000 loan, you will pay $1,000 at the settlement.
The purpose of points is to reduce the overall interest rate on the mortgage. Each lender has its own formula for calculating the value of points, but one example would be if you paid one and a half points to lower the interest rate of your loan from 6.25% to 5.875% or pay 2.75 points to reduce it to 5.375%.
The test is how long you will live in the home since the cost of the points goes down as time passes. If you need to borrow to pay the points, you will most likely lose any advantage since you have to pay the additional interest. If this is a first home, and you are hoping to move up to a larger home in a few years when you start a family, paying points is probably not a good idea, and here is why.
You have to look upon points that you pay as an investment in your loan. Paying 1.5 points to reduce your loan from 6% to 5.5% is an investment, but is it a smart one? It is rather like prepaying part of your mortgage interest bill.
There are many calculators on the internet that can help you calculate how much you can save in monthly mortgage payments by paying upfront points, based on the length of the loan or you can take the easy way out and contact a mortgage professional to do it for you.
For our hypothetical $100,000 loan, you would have to pay $1,500 in points to receive the interest rate reduction to 5.5%. How do you find the breakeven point in this situation, based on the different rates? The monthly mortgage for a 15 year 5.5% loan is 599.55 a month. The monthly mortgage for a 30 year alberta mortgage rate. 5.5% loan is $567.79 a month.
Since the lower rate saves $31.76 per month, you have to at this point compare that to what the upfront payment in points cost you. All you have to do is divide $1,500 by $31.76 and you will see that it will take 47.23 months for the payment to be fully amortized. In other words, if you don’t plan on being in the home for about 4 years, you gain nothing by paying the points.
However, after the 47.23 months have passed, each month payment is a savings. If you, unlike most homeowners today, stay in your home for the complete thirty years, you would have saved $31.76 over those years, which is a total savings of $9,933.58. calgary mortgage brokers
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