Shopping for a mortgage can be very complex for the general consumer. There are several factors which can affect the decision of whether to contract for a particular type of mortgage. These factors include but are not limited to the points and other fees associated with the mortgage, the mortgage type and/or term, the lock type and period, and the qualification terms. The instant question focuses upon only one of these factors–points. After we see how complex this one issue can be, it will be more evident that it is essential to work with a competent mortgage professional who can provide advice regarding all of the factors germane to the decision-making process when choosing a mortgage.
First, let us make sure that we know exactly what the term “point” represents. A point is part of the cost of a mortgage. The interest rate paid on a monthly basis is also part of the cost. A point is a fee which is equal to one percent of the mortgage amount. In other words, one point on a $100,000 mortgage would be equivalent to $1,000 in fees. Mortgages are available with no points at a higher rate and are also available at lower rates with additional points. It is important to note that the points may not represent all the fees associated with the cost of the mortgage.
In choosing between a higher interest rate mortgage with no points versus a lower interest rate mortgage with additional points, we must first make a few important assumptions:
•That the applicant has the income necessary to qualify for the higher payment associated with a no point mortgage;
•That the applicant has the cash necessary to pay the points if they opt for the lower payment mortgage (or the equity to finance the points if a refinance);
•That any seller contributions (the seller may be paying part of the closing costs–including points) are taken into consideration.
Two Point Options
$100,000 mortgage amount with a 30-year fixed rate
|Option 1||Option 2||Difference|
|$507 monthly||$537 monthly||$30 monthly lower|
|0 points||1.5 points||$1,500 higher fees|
Analysis: $1,500 higher fees divided by $30 monthly savings = 50 months to break even on the cost of the points. The analysis does not take into consideration the tax deductibility of points as opposed to the tax deduction of higher mortgage payments and the present cost of money as opposed to the future value of the same dollars. Future dollars are worth less because of the risk of inflation. Again, the numbers are approximate and fictitious.
If we assume that the buyer can afford the points and qualify for the payment, the decision as to whether to pay points will typically narrow down to one major question…how long will the homeowner have the mortgage? Points are a cost and they carry the benefit of a lower payment. Over time, the benefit of lower payments will become equal to or surpass the cost of the points. If one has the mortgage for less than three years, they are likely not to recapture the costs of points. If they have the mortgage for four to six years, they are likely to break even. Beyond that time, the benefits will outweigh the cost of points. This economic scenario is illustrated within the chart located in the center of the page.
Note that we are not indicating that the home is sold. It is just as likely that a homeowner will refinance to end the mortgage as opposed to selling the home. We must measure how likely that the homeowner will move and/or rates will decrease in the future. What factors might determine a future refinance?
•If the homeowner opts for an adjustable rate mortgage, they are more likely to refinance in the future. Generally, pay less points, especially for short term adjustables such as one year ARMs.
•If the rates are historically low, pay as many points as possible (within reason). With the low fixed rates available today, you are much less likely to refinance in the near future.
Human nature often causes us to make the wrong decision with regard to points. When rates trend up, we tend to pay more points to get the rate down to an affordable level. However, after rates trend up we should opt for the highest rate and lowest points available because it is more likely that we will refinance in the next year or two. When rates go down, we surmise that rates are so affordable we should not pay points. It is at these cycles (such as today) that we should opt to make a decision for the longer term.