If and when you take out a mortgage, you’ll be faced with an important choice. To pay or not pay mortgage points.
In short, those who pay points should hypothetically secure a lower interest rate than those who do not pay points, all else being equal.
That’s because mortgage points, at least the ones that are bona fide discount points, are just a form of prepaid interest.
So you’re essentially paying a portion of the interest on the underlying loan upfront, as opposed to monthly over the life of the loan term.
The caveat is that it is possible for a home buyer or refinancer to obtain a lower mortgage rate than another borrower without paying any points, assuming they shop around and use a mortgage lender with lower rates.
Now back to whether you should pay points or not, especially at a time when mortgage rates continue to hit new all-time lows.
In an environment where mortgage rates are declining over a long period of time, paying mortgage points can be a mug’s game.
After all, you paid money upfront for a lower mortgage rate, only to find yourself back at the refinancing table. No bueno.
Indeed, many homeowners these days are asking the question, how soon can I refinance again?
Those who went the no cost refinance route have basically nothing to lose, other than maybe resetting the mortgage clock.
While those who paid several thousand dollars in closing costs, of which points made up the lion’s share, potentially have a lot to lose if they take out a new home loan right away.
|$400,000 Loan Amount||Pay Points||Pay Extra Monthly|
|Upfront Cost of Points||$4,000||$0|
|Loan Balance After 48 Months||$362,324||$361,316|
|Total Paid After 48 Months||$79,840||$80,640|
Let’s consider a $400,000 loan amount where a borrower pays one discount point to obtain a rate of 2.5% on a 30-year fixed mortgage.
And an alternative where the homeowner decides not to pay any points and settles for a rate of 2.75% instead.
The homeowner who paid $4,000 upfront would enjoy a monthly payment of about $1,580 versus the higher payment of $1,633 for the no-points borrower.
That’s a difference of about $53 per month, which would take around four years to recoup when you consider the lower-rate mortgage reduces the outstanding principal balance faster.
Now if you didn’t want to pay that extra $4,000 at closing, you could simply go with the higher mortgage rate but still wind up with a similar mortgage balance after four years.
Simply pay $47 extra each month ($1,680 total) and your remaining loan balance would be around $361,316 after 48 months.
Meanwhile, the cheaper mortgage would be roughly $362,324 at that time with regular monthly payments.
That’s about a $1,000 difference for an extra $4,800 in payments over that time ($100 x 48). So the net cost is $3,800 over that time, slightly lower than the $4,000 paid upfront.
In the end, both borrowers are in a similar spot after four years, but the borrower who didn’t pay points had the option to refinance if rates moved even lower.
And they could pay extra each month to stay on track or just pay the minimum and invest the money elsewhere at hopefully a higher return.
Now, after those first four years are up, the math will start to benefit the homeowner who opted for the lower-rate mortgage in exchange for upfront points.
But how many homeowners are actually keeping their mortgage (or house) that long? Lately, not many.
In summary, this is just an inverse way of looking at buying mortgage points, which illustrates how those who don’t stick around for a long time can actually benefit from not paying points.
The counterargument is that rates are at record lows and will likely only go up from here, so if you can lock an even lower one in today, why not?
But we thought they had hit rock bottom years ago, only for them to defy the odds over and over again.
And as I mentioned, a borrower who actually takes the time to comparison shop could enjoy the best of both worlds.
[Watch out for low mortgage rates you have to pay for!]
Before creating this blog, Colin worked as an account executive for a wholesale mortgage lender in Los Angeles. He has been writing passionately about mortgages for nearly 15 years.