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Paying points to reduce your refinance rate

Posted by  on Feb 07, 2014
 

When it's time to evaluate your refinancing options, you're most likely to start by comparing mortgage rates online to see if today's rates are lower than what you're currently paying. While mortgage rates are an important part of your calculation about whether to refinance, you should be aware that average mortgage rates are just that -- an average, not exactly what you'll pay.

Mortgage rate estimates

The mortgage rate you will pay depends on your credit, the type of property you are buying, your loan term and loan-to-value. If you want to get a general idea of what your payments will be for a loan for various terms at different rates, you can use a mortgage refinance calculator. The only way to know for certain what your individual refinance rate will be is to contact a lender and provide information about your loan and finances.

You can also choose to lower your mortgage rate by paying points when you lock in your mortgage loan.

Paying points in a refinance

When you compare loan quotes, you can ask a lender what the difference would be if you pay one or two points or more. One point, equal to one percent of your loan amount, will lower your interest rate by a variable amount. Generally, each point you pay will lower your rate by one-fourth or one-eighth of a percent. If you're borrowing $300,000, one point would be equal to $3,000. If you want to reduce your rate by one-half of one percent, that would cost you $6,000.

Benefits of paying points

Choosing to pay points to capture a lower mortgage rate can lower your monthly payment and save money on interest over the life of your loan. The amount you would save varies according to the size of the loan and your interest rate. For most people, paying points makes the most sense when you plan to stay in your home for a long time because of the cumulative impact of interest savings. If you plan to sell your home quickly, it may not make sense to pay cash for a lower rate that will be in place for only a few years.

Drawbacks to paying points

The main drawback to paying points is that you're drawing down on your cash reserves to pay less in interest. Before you choose to do this, be sure there aren't better uses for this cash such as keeping it available for an emergency, investing it, saving for retirement or even using it to prepay your mortgage and reduce your loan balance.

Tax implications

Another thing to keep in mind when you're considering whether or not to pay points should be taxes. When you pay points for a purchase loan, you can usually deduct the points on your taxes; for a refinance, you must prorate the points over the entire loan term, such as 30 or 15 years of tax returns.

The decision to pay points on a refinance should be made in the context of your entire financial plan and the availability of cash. While it's a great feeling to tell your friends that you got a rock-bottom low interest rate on your mortgage, that's not worth emptying your bank account.

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