Let’s get right to the point. What point? Points. I don’t get it. What’s your point? The point is points — what are they, how do they work and should I pay them when I get a mortgage? There’s a lot of confusion about points and when a borrower researches his or her best mortgage options, inevitably there will be an element of points in the debate. So in order to help ourselves find the best terms on any home loan, we need to get this point thing under our belt.
Point One (One Point)
Simply, one point equals 1 percent of the loan amount. If you have a $500,000 mortgage, 1% of it is $5000. Similarly, fractions of a point work the same. In our example, 1/2 point on $500K is $2500. If a lender says you can get any certain rate by paying 3/4 of a point, simply take your loan amount and multiply it by .75%. This rule never changes, despite loan size, type, borrower profile, etc. One point is one percent of the loan amount.
Let’s put a finer point on points. We’re going to focus on “discount points” and not “origination points.” Discount points are meant to have a direct impact on the rate that the borrower obtains. “Origination points” are a cost to get the loan itself — independent of the rate provided. An important concept to know here is that on any given day, a mortgage lender can offer the public a range of rates. Let’s say a borrower qualifies for a 4.000% rate with “zero points.” This means that without paying any discount cost, the borrower’s rate would be 4.000%. Easy, right? OK. So what happens if the borrower wants a rate of 3.75%? Is that possible? Yes. But in order to get the lower rate, the borrower will need to “pay” the lender what it would cost to bring the 3.75% rate to “par,” meaning to level equal with the cost of the money at 4.000%. On the lender side, there is more cost associated with lower rates and an “inverse cost” (aka, lender credit) associated with higher rates. So on the scale of, say, 3.500% to 4.500%, the lowest rate would have the highest cost to obtain and the highest rate would have the highest “rebate” or lender credit. Due to regulation, lenders cannot profit any more or less depending on the rate chosen, so the cost or credit to obtain any rate must come from, or go to, the consumer.
Does it make sense to pay points when you get a mortgage? Now I must tell you that as a veteran loan originator, many borrowers pay points to get a “sexy” rate. Let’s say a 4.000% rate is available with zero points, but that a 3.875% rate can be bought for a half point. Some will make that investment just to have the ‘3’ handle on their “water cooler rate.” OK, fine. It happens. But the decision to pay points should always include a math calculation and fortunately, it is a simple one. Let’s use our example again and say that 4.000% is available on a $400K loan at 0 points, or “par.” The payment on this loan would be $1910. Now let’s say this borrower hopes to get a rate of 3.750%. The lender comes back and says that 3.750% will cost .75% (3/4 of a point) to obtain. So, we have an investment of $3000 that will be paid at close as discount points, but in return, this borrower will get a 3.750% rate instead of 4.000% for the life of the loan. The payment savings per month in this case would be $58. Remember that the borrower is “investing” $3000 at close to get the $58/M savings, so we divide the cost by the savings to determine the number of months it will take to recover the investment. In this case, it will take 52 months, or a little over four years. If this borrower plans to be in the home and not replace the mortgage within the that time, the choice to pay points may indeed be a good one. However, if the borrower does sell or refinance in that initial window, the investment (or part of it) really will not return. Yes, the borrower got the better cash flow per month, but he/she never realized the true savings the lower rate would provide.
The decision to pay points is a personal one. This is not a “right or wrong” choice and is highly individualized to the scenario and the borrower’s financial plans and goals. Helping a buyer or someone looking to refinance understand how points work, and if paying them is worthwhile, is a conversation we are always happy to have. Call any time if I can be of service!
In the right direction,
Robert J. Spinosa
Vice President of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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