What’s the Point of Paying Points?
Home buyers often want to know whether or not they should pay points on a loan. The truth is, each borrower needs to consider his/her own unique needs to answer this question. The definition of a point is equal to one percent of the loan amount. For example, on a $500,000 loan, one point would equal $5,000. Paying one point will typically lower your interest rate by about ¼ %, and it takes about four to five years to recoup the cost of that point in the form of interest savings. And remember, points may be tax-deductible, which will effectively accelerate your return on investment. So in most cases, if your are fairly certain that you will stay in your home for more than 4 years, paying a point is a worthy investment. Here is an example:
- Loan Amount: $500,000
- Interest Rate (No Points): 5.00%
- Interest Rate (1 Point): 4.75%
- Annual Interest Savings by Paying 1 point = $1,250 (.25% X $500,000)
- Cost of Point = $5,000 (1% X $500,000)
- Time to Recover 1 point ($5,000) = 4 Years ($5,000/$1,250)*
A mortgage broker or loan officer should be able to provide a home buyer with options of paying points or no points and offer strategic advice as to which option best suits the goals and risk-tolerance levels of the home buyer.
* This timeframe could accelerate if a CPA allows for a tax deduction of the $5,000