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Ask Dr. Don

Should I pay points?

Dear Dr. Don
I have 12 years left on my loan, and owe $82,000. I have the chance to borrow $100,000 at 6 percent with no points or 5.5 percent with 1.750 points for a 15-year fixed-rate mortgage. Which loan is the better if I want to pay off my loan in less than 15 years? Paying up to $900 a month isn't a problem.
Joe Juncture

Dear Joe,
Points come in two flavors, discount and origination. Origination points are paid to the originating lender and pay for some closing costs. Discount points are prepaid interest. You can "buy down" the rate used to compute your mortgage payments by paying discount points.

Points are an expensive proposition if you don't stay in your house very long. If you can't fathom a move in the next five to seven years, then you can consider paying points to reduce your interest rate.

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Think of discount points as an investment. By investing the money up front you have lower monthly payments and may have lower total interest expense. For you to have a lower total interest expense, you have to stay in the house long enough for the cumulative difference in monthly payments to exceed the up-front cost of the points.

This Bankrate feature provides additional information on measuring how long you have to stay in the house to make paying points worthwhile.

The table below shows the decision between your two financing choices. By paying the 1.75 points, or $1,750 on a $100,000 loan, you reduce your monthly payment on a 15-year fixed-rate mortgage by about $26.77 a month.

No Points
Loan amount
Interest rate
Discount points
Origination points
Points paid at closing
Monthly payment
Payback in months
Total interest expense

This example shows that the payback to paying points is more than five years. It's important to note that this approach to payback is only an estimate. Whether you can use the mortgage interest deduction, the difference in your home equity position, and what rate of return you can earn on your investments influence how long you need to stay in the house to make paying points worthwhile.

The table also assumes that you are paying the points in cash at closing. If you finance the points the payback is even longer.

You don't want to get so deep into the interest rate analysis that you forget to compare the difference in closing costs between the two loans. Comparing the APRs is a quick and dirty way to evaluate the difference between the two loans, but since lenders are allowed to use estimates of closing costs, it is only an approximation. Use the FTC's worksheet if you want to make a more thorough comparison of costs.

If you use the difference between the two monthly payments to make an additional principal payment, you can use Bankrate's mortgage payment calculator to see how these small payments really contribute to reducing your total interest expense. If your monthly budget allows you to pay $900 a month, the additional principal payments will increase your interest savings even more.

I'm assuming that the cash-out component of the refinancing is important to you achieving your financial or life goals. I'm also assuming that your home is worth more than $120,000, so you don't have to consider the expense of private mortgage insurance (PMI) on the loan.

Even though you're refinancing, borrowing the extra $18,000 and extending the loan to 15 years from 12 years is likely to increase your total expenses. Make sure that it's worth it to take on that additional expense.

-- Posted: Nov. 26, 2001

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See Also
The true costs of 'no-cost' refinancing
When should you refinance your mortgage?
Is your refi rate as good as new?


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