Should I pay points on a mortgage loan?

Posted by  on Oct 10, 2014

Q: As a general rule, is it worth paying points up front to get a lower interest rate on a mortgage loan?

A: Here is the thing about general rules and finance -- generalizations are dangerous. These decisions come down to the specific financial terms of each case, and also to the borrower's personal situation and outlook. Thus, paying the points may be the right decision for one borrower but not for another. Here are some of the things that affect that decision:

  1. How do the points affect the Annual Percentage Rate (APR)? When obtaining mortgage quotes, be sure to make comparisons using APR rather than the simple interest rate. APR takes the interest rate but then factors in up-front costs like points by calculating them as a percentage spread over the life of the loan. This gives you a consistent way to compare home loans that are structured differently in terms of front-end costs and interest rates.
  2. Do you expect to pay the mortgage off early? For example, if you are getting a 30-year mortgage but anticipate paying it off in 10 years, you should calculate APR using 10 rather than 30 years as the loan term. This is important because shortening the payback period increases the percentage impact of up-front costs.
  3. Do you have a cash-flow cushion? Saving for a down payment tends to tap out the cash resources of first-time home buyers, and then there are always unexpected expenses when you buy a home. If buying a house is going to stretch your current resources in this way, it may be wise to pay a slightly higher interest rate in order to avoid adding points to your immediate expenses.

In short, APR helps you measure which loan option is cheaper, but both the assumptions that go into that calculation and the trade-off of the importance of up-front vs. ongoing costs may vary from borrower to borrower.


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