How can I save on mortgage points? How are mortgage points calculated?

A mortgage point refers to interest paid up front and is equal to one percent of the amount of the mortgage. Thus, on a $100,000 mortgage loan, five points would equate to $5,000.

Paying points can lower the interest on a mortgage. Two points paid might bring the interest rate on a loan down about half of a percent. The difference between paying 6.75% on a thirty year $100,000 loan and paying 6.25% on the same loan is about $30 on the monthly payment and $12,000 over the life of the loan; obviously, the larger the loan amount the more savings on both the monthly payment and the total loan paid. If you can afford to pay points and plan to be in your home for a long time then paying points may be a good idea.

How do you know if you should consider paying points?

First, how much cash are you able and willing to put down? If you are short of cash, then paying points probably isn’t an option. Second, what is your income relative to your debt? If your debt load is high you may have to pay points. Paying points will give you a lower interest rate and a lower payment. Having a lower mortgage payment may bring your total debt to income ratio in line and make it easier to qualify for the mortgage you need.

Once you have decided if you are equipped to pay points and want to do so there are three final considerations: How long do you plan to be in your home? Do you think you may refinance your home in the next two to three years? How much would the money you are using to pay points earn for you if invested elsewhere?

It will take almost five years to recoup the cost of paying two points on a 30 year $100,000 loan financed at 6.25% versus a no points 30 year $100,000 loan financed at 6.75%. Two thousand dollars placed in a certificate of deposit earning 3.5% would yield a pre-tax return of more than $375 over five years. In this case, if you plan to stay in the house less than five years or to refinance it in less than five years, then think about choosing the higher interest rate and putting the $2,000 in a CD. However, if you have ample cash for your down payment and other closing costs and plan to stay in your home without refinancing for more than five years then paying a few points may be advisable.

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