POINTS vs. NO POINTS

So you’re in the market for a mortgage. After hearing about all the options and products, your head is probably spinning. If that weren’t enough, after you select a mortgage program, you then have to decide whether to pay points, and how many.

So what are points, anyway? Points are basically prepaid interest. One point equals one percent of the mortgage amount. One point on a $200,000 mortgage is $2,000.

People are often tempted to pay points because it will reduce their interest rate. And why not? If it saves you money in the long run, then it must be good. But the reality is that it often doesn’t work out that way.

Let’s look at an example: You take on a $200,000 mortgage with a 30-year fixed-rate. Your lender offers 8 percent with no points, or 7.75 percent with one point, or 7.50 percent with two points, and so on.

Generally one point equals a quarter of a percentage point. It’s not a hard and fast rule, but it usually works out that way.

• The 8-percent/zero point option equates to a monthly mortgage payment of $1,467.
• The 7.75-percent/one point option equates to a $1,433 monthly payment, but with $2,000 paid up front.

So your choices are: save $2,000 now, or save $34 each month going forward.

It’s quite natural for you to make a few quick math calculations: $2,000 divided by $34 equals roughly 59. So 59 months (nearly five years) from now, the point you paid will pay for itself.

This is probably how some mortgage bankers will explain it to you. In turn, you might respond by saying: I plan to live here more than five years so the point makes sense. That can be a big mistake. Worse yet, it’s the kind of mistake that goes unnoticed. The simple calculation is flawed; that’s the whole problem. This is one case where simplicity isn’t good.

Here’s why: The question really boils down to how you can best use that $2,000. You can pay a point, you can invest it, you can pay down other debt, or you can put it toward a bigger down payment on your house. If you apply it toward the down payment, now you have a mortgage balance of $198,000.

This changes the original choice you were faced with above. Now the choice is: 

• The 8-percent/zero point option gets a monthly mortgage payment of $1,452 with the lower starting balance.  
• The 7.75-percent/one point option equates to a $1,433 monthly payment, but with $2,000 paid up front.

So now your choice is: put the $2,000 toward the down payment, or pay the point and save $19 each month going forward. When you do the quick math, you will divide $2,000 by $19 and come up with about 105 months or nearly nine years. This isn’t quite the no-brainer the previous decision was.