Should I Pay Points?
There is an inverse relationship between points and interest rate
on your loan. The higher the points you pay, the lower the
interest rate, and vise versa.
There are fees other than points associated with a loan
transaction, but for a given loan amount and service provider,
these other fees are fundamentally fixed. Other fees may include
appraisal, credit report, lender's inspection, tax service,
processing, underwriting, wire transfer, flood certification,
title and escrow fees, notary fees, recording fees, etc. For
example, consider a $100,000, 30-year, fixed rate loan on a home
valued at $200,000. No matter what the points and interest rate
you pay, an independent appraiser won't give you a "zero-fee
appraisal", nor will a title company give you rebate pricing for a
policy of title insurance.
Because of the inverse relationship between points and interest
rate, you can obtain a rebate from the lender to cover some or all
of your points and other fees. By increasing the interest rate on
your loan, the lender might pay some or all loan fees. By reducing
the interest rate on your loan, you'll pay some or all of the loan
fees.
As a borrower, you should answer these questions before you commit
to a new loan: Should I obtain a lower interest rate, pay points,
loan fees, or both? Should I get a higher interest rate and reduce
out-of-pocket fees? To answer these questions, estimate how long
it will be until you plan to sell or refinance. The task then
becomes finding the interest rate / fee combination which is the
least expensive during this window of time.
Here is a hypothetical example. For simplicity, "other fees"
are fixed at $1,000. You own your home and are interested in
refinancing your high-interest loan to take advantage of a new,
low-interest loan. The interest rates for zero point / zero fee
loans are well below your current rate, so you know it's time to
refinance. Your employer has indicated you might be transferred in
approximately three years. You compare three rate / fee
combinations to identify which is the least costly over the next
three years. You're considering a 30-year, fixed loan.
Comparing the expense of different loans allows us to consider
only the interest portion of the monthly payments. The principal
portion of the monthly payment is not considered an expense.
Therefore, only the interest portion of the monthly payments are
considered in these examples. A financial calculator or
spreadsheet program can provide the interest portion of the
monthly payments. Here are the loan comparisons.
| Loan: 30-year, fixed, $100,000, 8.0%,
monthly P&I payment = $733.82 |
| Month |
1 |
2 |
. . . |
23 |
24 |
| 8.0% |
Interest |
666.67 |
666.22 |
|
656.11 |
655.59 |
| |
Points |
0 |
|
|
|
|
| |
Other Fees |
0 |
|
|
|
|
| |
Cumulative Total |
666.67 |
1332.89 |
|
15,214.70 |
15,870.29 |
| Loan: 30-year, fixed, $100,000, 7.5%,
monthly P&I payment = $699.28 |
| Month |
1 |
2 |
. . . |
23 |
24 |
| 7.5% |
Interest |
625.00 |
624.54 |
|
614.10 |
613.57 |
| |
Points |
0 |
|
|
|
|
| |
Other Fees |
1,000 |
|
|
|
|
| |
Cumulative Total |
1,625.00 |
2,249.54 |
|
15,252.35 |
15,865.91 |
| Loan: 30-year, fixed, $100,000, 7.0%,
monthly P&I payment = $655.37 |
| Month |
1 |
2 |
. . . |
23 |
24 |
| 7.0% |
Interest |
583.33 |
582.86 |
|
572.14 |
571.60 |
| |
Points |
1,000 |
|
|
|
|
| |
Other Fees |
1,000 |
|
|
|
|
| |
Cumulative Total |
2,583.33 |
3,166.19 |
|
15,290.61 |
15,862.21 |
The cumulative total for each loan represents the total expense
related to the loan at the end of a given month. Initially, the
expense of the 8 percent loan is much lower compared to the others
because the 8 percent loan is free of out-of-pocket closing costs.
The 7.5 percent loan is a zero point, $1,000 closing costs loan.
The 7 percent loan example requires the borrower to pay points and
fees. Initially, the 7 percent loan is the most expensive. At the
end of month twenty-three, the 8 percent loan is still the least
expensive. At the end of month twenty-four, the 7 percent loan is
the least expensive. If we were to carry out these examples, the 7
percent loan would continue to be the least expensive. This
comparison suggests that you should take the 7 percent loan.
You'll be in your home for three years, and beginning in
the second year you start saving money with the 7 percent loan. |
