What does it mean to “pay points” or not to pay points when you’re buying a home? Is it beneficial to pay points or not? How much money could you save?
Can we make this mortgage decision easier to understand? You bet, read on!
A “point” is an upfront fee that is paid at closing to reduce your interest rate. One “point” is always 1% of the loan amount. For instance, using a $600,000 loan amount, one point would cost $6,000 at closing.
Usually, you don’t have to pay points if you don’t want to (except with adjustable-rate mortgage loans where it may be mandatory to pay a point to guarantee the lender a yield).
However, by paying points, you’ll decrease your monthly payments and you will decrease the total amount of interest paid over the life of the loan.
How Should You Decide To Pay Points Or Not?
The two main questions you must ask yourself are:
- Can I afford to pay points?
- How long do I plan on keeping the property?
Paying points will increase your closing costs, so you must determine if this additional cost is one you can afford to pay. If you are already stretched thin financially, then you might want to keep reserves you have left in your bank account rather than using it to buy down your rate.
On the other hand, say you can afford to pay points, it doesn’t necessarily mean you should.
Traditionally, it takes roughly 4-5 years to recoup the costs of paying points.
Take A Look At This Example:
- Paying 2 Points: $600,000 loan amount @ 3.00% = $2,530 (principle & interest)
- Paying 1 Point: $600,000 loan amount @ 3.25% = $2,611 (principle + interest)
- Paying No Points: $600,000 @ 3.50% = $2,694 per month (principle + interest)
*Paying 2 points would actually save you $164/month in mortgage payments ($59,040 in total interest over the life of your loan) and will also cost you an additional $12000 in upfront closing costs.
If you take your costs ($12000) divided by your savings ($164) you can determine that it would take you roughly 73 months – or a little over 6 years – to recoup your upfront costs of $12000. So, if for some reason, you don’t think you’ll keep the property/loan longer than 5 years, then it probably wouldn’t be a wise financial move to pay for points.
Now, if you do plan staying long term – then paying points may be the right decision for you.
Paying Points with a VA Streamline Refinance
The thought process when determining whether or not to pay points when doing a VA streamline refinance is a little different since the refinance program is something you can do more than once (as long as your new rate is lower than your old rate) and you can finance the points, so it won’t reduce the amount of cash you have in your bank account.
- For Example
Someone has a 4% interest rate and can reduce their rate to 3.5% without paying points or 3.00% by paying 2 points. They decide to pay the 2 points or $12000 in additional costs in order to get the lower interest rate and payments. Then let’s say in 6 to 12 months, rates dropped again and now you can get 3.00% without paying points at all! If this was the case, it would be very disappointing to waste $12000 when they could now receive the same rate for for no points.
- The Flip Side
There is no guarantee that rates will drop in the future. Ultimately, you’ll have to go on a gut decision about what you feel like doing. If you can save a few hundred dollars with a streamline refinance without paying points, take this route. If rates go down significantly after your refinance, then you can refinance again without paying points. If rates don’t go down, at least you are still saving a few hundred dollars from your original loan!
As your local VA loan lender in Hawaii, we believe in giving you the best information on Hawaii home buying and your VA loan benefits. If you have any questions, please don’t hesitate to give us a call at 808-792-4251.