Why would I ever WANT to pay points for a mortgage?
November 9, 2006 | Mortgage | 
2 comments
I think we can all agree there is no free lunch. With that said it is fairly obvious that if you are not paying any points or fees that the lender MUST be getting them from somewhere?just not your pocket..right?
Wrong. Brokers are paid a ?Yield Spread Premium? (YSP), more commonly called a rebate. This is paid by the lender. The broker can request pricing with no rebate (PAR) and pass on the lower rate to you but let?s remember?no free lunch. If you are getting the loan at PAR you pay the broker points. If you aren?t paying the points the broker requests a rate from the lender that pays him the required points as a rebate. This is obviously a higher rate than at PAR. So even when you pay no points it comes out of your pocket in higher monthly payments. This is the key to deciding when it makes financial sense to pay the points and when to take the higher rate. The longer term you keep the loan the more it makes sense to pay the point(s) for the lower rate. The average recoup time for money spent on points is 2 ? 5 years (depending on multiple factors). Here is an example:
$100,000 @ 6% interest only = $500 per month
Cost = 1 point of loan amount = $1000
$100,000 @ 6.5% interest only = $541.67 per month
Cost = no points
The difference in the monthly payment is $41.67 per month. The cost of the 6% loan is $1000. Therefore, the recoup time is 2 years. This is a common example for someone with good credit at today?s rates. For every year thereafter the savings of $500 a year would be the benefit of the point paid on the front of the loan. That?s a 50% return on your $1000 investment each year thereafter. To make even more of an impact you can pay additional points to buy the rate down further. This makes great sense on the longer term finance plans because of the additional savings. What is better than an investment in your own home that pays 20 ? 50% per year? Lastly, the money spent on points will fall in the non recurring costs category and are tax deductible.
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So you pay a ‘point’ to reduce the interest rate slightly? Is this always better than simply putting that money toward a larger down payment and borrowing less? I’m clueless on this stuff, but I’m coming to the point where I’ll be buying a home and I’d love to understand it.