All About Points

Points, also known as Discount Points, are a source of confusion for many home loan borrowers. When shopping for a loan, you have many options with respect to paying points.

A point is calculated as a percentage of the loan amount. For example, 1 point charged for a $100,000 loan would be $1000, and ½ point for the same loan would be $500.

The table below shows how different interest rates and points are typically shown. This example is also for a $100,000 loan amount. To get a loan with a rate of 7.25%, the borrower would not pay any points; however, to get a rate of 6.75%, 1.75 points ($1750) would be required.

Break Even Analysis

When considering whether or not to pay points, most borrowers use the Break Even Analysis method.  By paying points and obtaining a lower rate, you will have a lower payment.  It's up to you to decide whether the monthly savings is worth the up front cost of the points.

In the same example above, a $100,000 loan at 7.25% for 30 years has a monthly payment of $682.  If you pay 1.75 points ($1750), your rate would be 6.75% and your monthly payment would be $649.  This represents a monthly savings of $33.  So, in effect, you would have paid $1750 up front to save $33 per month.  At this rate, it would take just over 53 months (almost 4 ½ years) to recoup your investment or "break even".

What to Consider

Using the Break Even Analysis, take the following into consideration when deciding how many points to pay:

You should pay zero or close to zero points if:

• You plan to stay in your home for less than 3 - 4 years
• You think you will refinance your loan within the next few years
• You are applying for an adjustable rate mortgage

You should consider paying 1 or more points if:

• You plan to stay in your home for more that 5 years
• You plan to keep your property as an investment after you move
• You don't plan on refinancing in the near future

What are other people doing?

When making an important decision like this, it’s always helpful to see what other borrowers are doing. To help you make this important decision, we reviewed over 10,000 loans that we recently closed. Here is the breakdown of how many points other borrowers like you paid:

From this chart, it is clear that a majority of our borrowers (over 65%) pay between 0 and one half of a point.

Other things to consider

Tax deductibility is another factor to consider.  For a loan to purchase a home, the points paid can typically be considered tax deductible in the year they are paid; however, with a refinance loan, the points paid can only be deducted over the term of the loan.  Always consult your tax adviser for specific tax rules.

Another important consideration is how to pay for the points.  Although paying points will reduce your monthly payment, it may not always be your best option to pay them.  Homebuyers are often strapped for cash and the money that would be allotted for points may be better used for furniture, new carpet or window coverings, especially if the alternative was to use a credit card.  On a refinance transaction, the points can usually be included in the loan amount, rather than being paid out of pocket.