Should I Pay Points?
The best way to decide whether you should pay points or not is to perform a break- even analysis. This is done as follows:
1.) Calculate the cost of the points. **Note: 1 point is equivalent to 1 percent of the loan amount. Example: 2 points on a $100,000 loan is $2,000.
2.) Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Example: $50 per month.
3.) Divide the cost of the points by the monthly savings to come up with the number of months to break even. In the above example, this number is 40 months. If you plan to keep the house for longer than the break-even number of months, then it makes sense to pay points; otherwise, it does not.
4.) The above calculation does not take into account the tax advantages of points.
When you are buying a house the points you pay are tax-deductible, so you realize some savings immediately. On the other hand, when you get a lower payment, your tax deduction reduces! This makes it a little difficult to calculate the break-even time taking taxes into account. In the case of a refinance, the points are NOT tax- deductible, but have to be amortized over the life of the loan. This results in few tax benefits or none at all, so there is little or no effect on the time to break-even. If none of the above makes sense, use this simple rule of thumb: If you plan to stay in the house for less than 3 years, do not pay points. If you plan to stay in the house for more than 5 years, pay 1 to 2 points. If you plan to stay in the house for between 3 and 5 years, it does not make a significant difference whether you pay points or not!
Scott Gormley
Broker/Owner
Oak Valley Mortgage
2006 Chico Assoc. of Realtors Affiliate Chairman
Direct: 530.592.8362
Fax: 530.267.5555
Website: http://www.caloan.com/
"You find the perfect home, we'll find the perfect loan!"
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