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How Points Work
Points are calculated as a percentage of your total loan amount, and one point is 1% of your loan. Your lender might say you can get a lower rate by paying points, and you need to decide whether the cost is worth it. For example, suppose you’re getting a loan for $100,000. One point is 1% of the loan value or $1,000. To calculate that amount, multiply 1% by $100,000. For that payment to make sense, you need to benefit by more than $1,000. Points aren’t always in round numbers, and your lender might offer several options. For example, you might be able to pay 1%, 0.50%, or any other number, depending on your lender’s offerings. Compare those quotes among several other lenders to figure out which loan is best.
Benefits of Paying Points
Total Cost
When you borrow money to buy a home, you end up paying more than just the purchase price and closing costs—you also pay interest on your loan. Interest is the cost of using someone else’s money, and it can add up to a substantial amount when you’re working with a home loan. These loans may be for large dollar amounts, and they last for many years (resulting in some hefty interest costs). A lower rate means you’ll pay less interest over the life of your loan.
Monthly Payment
The interest rate is part of your monthly payment calculation. In general, a lower rate means a lower monthly payment, making it easier to manage your monthly budget. Points are a one-time cost, but you benefit from lower monthly payments for many years to come.
Taxes
You might get some tax benefits if you pay points, but that shouldn’t be the main factor in your decision. Depending on your situation, you may get those benefits in the year you pay points, or over a number of years. Check the IRS rules in Topic 504—Home Mortgage Points, and speak with a CPA before you decide on anything.
Deciding to Pay Points
If you can afford to pay for points, you’ll need to figure out whether it’s worth it. Here’s a general rule of thumb: The longer you’ll keep the loan, the more attractive points become. If you’re the type of person who likes spreadsheets, you can determine the optimal choice by looking at future values versus present values. However, a more practical approach for most people might be: Some tips to help you evaluate are:
Calculate different scenarios for how your monthly payment changes with points. Build an amortization table to see how your interest costs change over time. (You can use free spreadsheet templates to help.) Use an online points calculator. Ask your lender for calculations.
A spreadsheet or amortization table is probably the best tool for getting a detailed view of how points affect your loan. Most people don’t keep a loan for the full 30 or 15 years—you might refinance your loan or sell your house before then, and an amortization table allows you to spread the benefit of the points over the exact number of years you keep your mortgage.
