Choosing Rates vs. Points in a Mortgage Loan

Among the many decisions you will have to make when choosing a mortgage loan is whether or not to pay points. While a very high credit rating may give you the option of a low rate with no points, some borrowers will elect to pay points to reduce their interest rates.

For example, let's assume

you were shopping for a $180,000 mortgage. You might be offered a 30-year fixed-interest mortgage at a 6 percent interest rate with no points, or 5.65 percent with two points. A point is 1 percent of the amount of the loan; in this example, each point would be $1,800. Therefore, you would pay an additional $3,600 for the lower interest rate. Should You Pay Points on Mortgage Loans?

As is generally the case when mortgage shopping, part of the decision will come down to your current financial picture. If you have the money at the time of closing, after paying your closing costs and your down payment, you might very well want to pay for points.

The other key factor in your decision will be how long you plan to stay in the house. Unless you are planning to stay for more than five years, you will not benefit from paying points, because you will not be there long enough to cover the additional payment. Even if you are planning to stay put from five to seven years, you may not come out ahead. You will need to sit down with a calculator and determine whether you will benefit from paying points on your loan.

But over the long term, points can save you substantial amounts of money. If you are planning to stay in your home for 20 to 30 years, you should seriously consider paying points -- but only if you have the money available when you close.

Returning to the example above, let's assume that you are buying a $200,000 home, and putting down 10 percent, or $20,000. Closing costs generally run about 3 percent, or $6,000 in this case. What Are Mortgage Loan Closing Costs? Coming up with another 2 percent, or $3,600 may or may not be an option. The total of $29,600 can be a lot to pay at one time. And don't forget to account for other costs associated with a new home, such as moving and furniture.

There are some financial advisors that will tell you that skipping points and paying the slightly higher interest rate is the better option. Their argument is that by putting the money into a higher yielding investment, you can use your money to make money. While this idea is potentially very sound, these short-term, high-yield investments are inherently risky. You will have to decide if you are comfortable with this level of risk.

Ultimately, the key factors in your decision will be how long you intend to occupy the house and whether or not you can afford the additional cash layout at the time of the closing.