What is a point? A point is equal to 1% of the loan amount and is a fee that can be paid at closing in exchange for a lower interest rate for the life of the loan (in most cases the discount for paying a point is .125%-.375%). A point is disclosed on the Good Faith Estimate as an origination fee or loan discount. At the end of the day it doesn’t matter to you what the point is called. The bottom line is you need to decide whether or not you feel the upfront investment of paying 1% point is worth the discount in interest rate that you will receive. If you intend on having this loan for the long-term (i.e. > 5 years) then paying upfront points may be a good idea. However, for shorter term outlooks it generally does not make sense.
We typically recommend to our clients NOT TO PAY POINTS (adjustable rate mortgages are an exception)because in our experience the upfront cost of 1% point does not justify the long term savings. This is because we’ve found that most of our clients DO NOT keep their loans long enough to benefit from the modest interest rate discount that paying a point provides. Empirical data also supports our philosophy as the article below from the Seattle Times suggests.
Seattle Times Article about Points:
Report: Buying points rarely pays off
CHICAGO — A new report claims that borrowers tend to purchase too many points when selecting a mortgage and end up paying more than they would have with no points and a higher interest rate.
The study was co-authored by Abdullah Yavas, Elliott professor of business administration at Pennsylvania State’s University’s Smeal College of Business, and Yan Chang, of Freddie Mac. The two considered 3,785 individual mortgages originated from 1996 to 2003, looking at the points paid, interest rates and loan length.
Data showed that, on average, those who buy points are overestimating the amount of time they will hold their loans. They tended to pay off their mortgages about 37.5 months too early for the purchase of points to pay off,
defaulting, moving or refinancing before hitting a break-even point so the strategy made financial sense.
By purchasing points, borrowers lower the interest rate on the mortgage. One point is equal to 1 percent of the mortgage, charged as prepaid interest. Points paid to purchase a primary residence are deductible in the year they are paid on federal income-tax returns; points paid to refinance must be written off over the life of the mortgage.
“We underestimate the possibility that we may refinance in the near future — or refinance again in the near future — and we underestimate the possibility that we may have to move, either for job relocation or other
reasons,” Yavas said.
Only 1.4 percent of borrowers who purchased points held their loans long enough to make it pay off; of those who didn’t buy points, only 1.5 percent would have been better off purchasing them, according to the study.
However, Yavas pointed out that the data cover a time of decreasing interest rates and increasing property values, which led to a lot of refinancing.
The report also found that borrowers who buy points often don’t treat them as costs they can never recover and so are less likely to refinance. When they do refinance, they often do it late, perhaps hoping to compensate for
the points paid.
If a borrower “paid too many points and the interest rates come down quickly, refinancing right away would be the same as accepting the fact that you shouldn’t have paid those points,” Yavas said.
Yavas took an interest in the topic after he decided to refinance his own home a few years back and considered the trade-off between points and interest rates.