That’s a good question, and I’ll tell you how I determine the answer, based on your individual situation. But first, for those who are not familiar, I’ll explain how you can a lower interest rate by paying a point.
What Does Paying a Point Mean?
Let’s say today’s interest rate for a 30-year fixed rate is 4.25%, but you would really love 4.0%. You can opt to buy down your rate by paying one percent of your loan amount as an upfront closing cost. For example:
$200,000 loan, 0 points, 4.25% = $983/mo. principal and interest
$200,000 loan, 1 point ($2,000), 4.0% = $954/mo. principal and interest
By paying $2,000 upfront, you save $29/mo. on your payment.
How to Determine If Paying a Point is a Good Choice
Calculate the monthly payment (principal and interest only) for your loan amount using the two interest rates that are available. Then subtract the smaller payment from the larger payment to get the savings. This is X.
Now divide X into the upfront cost. That will give you the number of months it will take to break even.
If you plan to keep your loan longer than that, you’ll come out ahead by paying the point. But wait! If it takes too long to break even on your money, it doesn’t make sense–even if you do plan to stay in your house for that long. You don’t want to wait five years to just break even, because there are better things you could do with that money.
Let’s look at our example above:
$2,000 upfront cost divided by $29 savings = 68.9 months or 5.7 years
Waiting almost six years just to break even on my $2,000 is something you want to say “no thank you” to doing. If you don’t need to keep that money in savings for emergencies, you could do better by putting it toward your principal balance when you make my first payment.
How One Home Buyer Saved $2,234!
Last month, a U.S. Veteran who was buying a home using the zero down VA loan signed up for my coaching service. He emailed me the Cost Estimate Worksheet for the lender he was planning to use. He chose this lender because it had received so many positive reviews online. The loan officer was very nice and accommodating, so he felt confident, but decided to have me check his paperwork as a safety measure.
When I looked at his estimate, I was not pleased! He was getting an interest rate that should have been zero points, but he was paying 1% or $2,234. That is in addition to the lender’s fees of underwriting $495 and processing $395. After our telephone consultation, he knew what he had to do.
The next day, he had a loan with the same low rate, no points! Needless to say, he is happy he used my coaching/consultation service to save himself $2,234 in upfront cash. Now he can use that money for his own good!
Look at Interest Rate Options Before You Lock Your Rate
Before you lock in your interest rate, insist on being given at least two choices. If you could pay a point and lower your rate enough that you would come out ahead after only 1.7 years (as happened for another one of my coaching clients), then it is worth the cost–assuming you have the available cash without financial hardship, of course.
Sometimes, you need to pay only a fraction of a point (less than 1%) to get a lower rate. It varies from day to day. There is no set formula.
A good loan officer will offer you options. But if he or she fails to do so, ask for options. This is your home, your mortgage, and YOU should be the one who chooses your interest rate. Just make sure you do the math so that you choose your best option.
And remember, you cannot lock in your rate until you have submitted a fully signed purchase contract to the loan officer. Interest rates are tied to a specific property address. So wait until then to do your interest rate/point comparison.