When shopping for a mortgage the first sentence out of the mouths of my clients is "I don't want to pay points!"  Points are a dirty word in my business but, they're not the evil many people believe them to be, in fact they're no different than the commission you pay a Realtor to sell your home. 

Loan Officers and Mortgage Brokers earn their income one of two ways; they either charge you one or two points up front or they earn their income from the lender in the from of a yield spread premium (YSP). 

There are a number of things that determine your interest rate, the most common are your credit score, debt to income ratio and whether you'll be providing full documentation of or stating your income.  These basic factors affect the interest rate the most, the higher your credit score, providing full documentation and a level debt to income ratio the lower the interest rate.  Other factors that affect the interest rate are loan to value (LTV), cumulative loan to value (CLTV), loan amounts, owner or non-owner occupied, number of units, interest only, and whether or not you'll be impounding your taxes and insurance.

Let's take a look at Tom, Tom wants to purchase a home valued at $500,000 and wants to take out a loan in the amount of $400,000 or 80% of the homes value.

In this scenario we'll assume Tom has a 680 credit score, is providing full documentation, his debt to income ratios are level, and he'll be living in the home.

The Loan Officer has to earn 2 points or 2% to make a profit on this transaction

Choice One:

Loan Amount: $400,000
Interest Rate: 6.375% (pays the Loan Officer 2 points in YSP)
Interest Only Payment: $2,125

Tom does not have to come up with any out of pocket money; the Loan Officer is earning his income from the lender.

Choice Two:

Loan Amount: $400,000
Interest Rate: 5.625%
Interest Only Payment: $1,875
Points Paid: 2.00 or $8,000

Tom has now paid $8,000 or 2 points to reduce his interest rate; he's now saving $250 per month on his mortgage payment. 

Was it worth $8,000 to save $250 per month?  It was if Tom plans on being in his house more than 32 months, over the remaining 328 months of the loan Tom will save $82,000 in interest payments.

We'll use the same scenario as above but this time Tom is going to state his income.

Choice One:

Loan Amount: $400,000
Interest Rate: 6.625% (pays the Loan Officer 2 points in YSP)
Interest Only Payment: $2,208

The lender charged ½ a point to allow Tom to state is income.  Because Tom did not want to pay the ½ a point or $2,000 Tom's interest rate increased by ¼ of a point.

Choice Two:

Loan Amount: $400,000
Interest Rate: 5.625%
Interest Only Payment: $1,875
Points Paid: 2.500 (2.00 loan officers income, ½ for stating income) or a total of $10,000

Tom has now paid $10,000 or 2.5 points to reduce his interest rate; he's now saving $333 per month on his mortgage payment. 

Was it worth $10,000 to save $333 per month?  It was if Tom plans on being in his house more than 30 months, over the remaining 330 months of the loan Tom will save $109,890 in interest payments.

You're paying points one way or another; you either pay them up front (out of pocket) or over the length of the loan in the form of a higher interest rate.  When shopping for a loan be aware of your choices, compare apples to apples and decide whether it's in your best financial interest to pay points.  A knowledgeable loan officer will provide with different loan programs and payments that best suit your financial position.

Ed Brophy is founder and president of Synergy Mortgage, you can visit him on the web at http://www.synergymortgageloans.com/.  This information is not intended to be financial advice, please consult your financial advisor about which program is best for you.