How do you "buy" a better rate?
Do you plan on keeping your loan for a while? Then it may make sense to "buy" a lower interest rate by paying one or more "points."
How Much Do Points Cost?
The cost of each point is equal to one percent of the loan amount. For instance, for a $100,000 loan one discount point equals $1,000.
How Much Does Buying a Point Lower Interest?
Each discount point paid on a 30-year loan typically lowers the interest rate by 0.125 percent. That means a 7.5 percent rate would be lowered to 7.375 percent if you purchase one point.
Paying for points lowers your interest rate, because the lender receives the income in a lump sum at closing rather than collecting the interest as you make payments on your loan.
Should I Buy Points?
Whether or not paying points makes sense for you depends in part on how long you plan to keep the loan.
- Calculate the amount of your monthly payment at the interest rate you will be charged if you do not pay points.
- Calculate the amount of your monthly payment at the lower rate if you do pay points.
- Deduct the lower payment from the higher payment to find the amount saved each month.
- Divide the amount charged for points at closing by the monthly amount saved. The result is the number of months you must keep the loan to break-even on paying points.
Break Even Example
$100,000 Loan - 30 Year Term
- 7.5% Interest, no points = $699.21 monthly payment
- Buying 1 point for $1,000 = monthly payment $690.68
- Monthly Savings = $8.53
- $1000 / $8.53, = 117 months
Your break-even point is 117 months—or nearly ten years to recover the cost of buying the discount point (considering only the simple calculation of those funds at today's value).
|
