It’s time to purchase that new house and you are comparing lending options. You’ve met a couple mortgage brokers and maybe your agent has suggested their in-house person. There’s a lot of options and formulations to consider. Each mortgage is like a complicated recipe that would even make the people who constructed multi-level marketing payouts blush. One fairly common ingredient in loan offerings is points and you need to know if they work for or against you.
To answer that, you first have to understand the difference between the two types of points:
- Origination points – This is a fancy term for charging you a fee to process all the paper work. One “point” is simply, one percent of the loan amount. So if you are borrowing $300,000, then one point will cost you $3000. Most often you can negotiate to reduce this amount.
- Discount points – This is more commonly seen and the most simple explanation is that it is prepaying part of the interest from the total loan… Sort of. Many lenders will allow you to negotiate the dollar amount of these back into the loan (so now you’re paying interest on interest). On the flip side, you can offer to pay more in discount points to reduce your loan interest. Just how much of a reduction in negotiable, but a good median is to look for one point to take off about 1/4 percent.
So, you might ask, is it worth it to pay discount points and save interest? If you plan to stay in the home for a long time – like the full 30 years of the mortgage – the common thinking is that it could be good. In a recent USA Today article, an example was given in which a $250,000 loan at 4.5% interest would cost you $456,000 over 30 years. Paying 2 discount points ($5000) to lower your rate by 1/2% would lower the total by $26,000 over those 30 years. Not bad. What would it take to beat that with the same $5000?
The answer is 5.6%, which yields a return of $25,628.20. So, sticking it in a CD over and over isn’t going to do it, but using it toward any decent investment real estate or even a mediocre stock portfolio should have you seeing returns better than that.
If you go the Dave Ramsey mutual fund route, you are looking at 12%, or $149,799.61.
The S&P average of 9.14% in the last 10 years yields $68,942.73.
Investing in real estate… Well, that’s going to give you more angles of return, so it’s harder to quantify quickly.
In short, though I think you can see that you might want to look at other options before you go ahead and pay those points.