Understanding Pay Points-Is It Really Worth It

Understanding Pay Points-Is It Really Worth It

If you have ever purchased a home before or applied for a mortgage, you may have heard the term "points". In this guideline, we're going to cover some of the basic information on just what exactly a point is and why you may or may not want to purchase one.

But before we begin, it's important to understand the difference between points and origination fees. An origination fee, which is charging points, is generally a fee the lender will charge for working on, and processing the loan. Discount points are fees the lender will charge to lower the interest rate on the loan. Discount points are designed to pay interest up front at closing.

Purchasing Points

A purchasing point will also lower your monthly payment. Keep in mind one point usually costs one percent of the loan. let's go over a simple calculation to find the cost of one point. Let's assume the loan amount for your new home is $100,000. To calculate the cost of one point, multiply it by one percent or point is 0 1, which equals $1000. In other words, an additional $1000 up front will reduce your interest to point 1.25%.

Calculating Your Payback Period

There are different ways to look at points and if they are worth it. In any decision it comes back to the basics of the benefits versus the cost. The most common way to weigh these two factors when it comes to the point, is payback period. Payback period is the amount of time it takes to pay back the exact same amount you initially pay for the points. There are 4 steps in calculating the payback period

Step 1: Involves calculating your monthly payment without the discount points.
Step 2: Calculate what the monthly payment would be if you purchase the points
Step 3: To find the difference, subtract the two payments.
Step 4: Divide total cost of points by the monthly savings. This will give you the number of months it will take to make the difference up from the cost.

How To Determine If Its Really Worth Your Money

Let's go over the calculation we covered. First, we will assume our loan is still one hundred thousand. We will also assume that we were offered the option to buy 2 points under 7% 30-year mortgage. In this example, the monthly payment without the points is $665.30. Our monthly payment with the points is $656.93. Now we will subtract these two to find our monthly savings.

Now that we know how to calculate the cost of loan points, we also know that the total cost of our points is $2000, we then divide this by our savings to get $119.76 or about 120 miles. After all of our calculations, we can now decide if it's worth. The first thing to consider is if you have the extra money to pay it front. If you do you can lower your monthly payments by purchasing points.

Conclusion

Lower payments are good, but there's still another factor to consider-a payback period. If you plan on living in your home for longer than the payback period, you may save money in the long run also. The longer you stay in your home, the more saving people experience. In our example, we would save $200 a year, and $6000 over the length of our mortgage.