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Points or No Points
Sep. 24th, 2009
YUMA, AZ – The question of paying discount points on your mortgage should be answered by one single question. How long do you need to borrow this money?
The length of time you need to borrow the money has a profound impact on the entire mortgage process. The answer to that question is the key to selecting the right components to your total loan package. A true mortgage strategist will help you answer the question of whether you should be paying upfront points.
This process of determining how long the money will be borrowed for should take some effort and honest deliberation. This is as critical of a decision as any other life planning event. The correct answer to points and program is based upon each individual’s needs, plans, goals, and desires. Is there a life changing event in the foreseeable future? That event could be job transfer out of town, marriage, divorce, children, retirement, investing, additional schooling out of town, etc…
Points vs. No Points--Points are often a misunderstood concept for first time home buyers. Points are nothing other than interest paid up front (at the time of closing), to obtain a lower interest rate on a loan. One point is equivalent to 1% of the amount of money borrowed. If you are going to borrow $300,000 on your loan, one point would equal $3,000 up front. This generally generates 1/4 to 3/8 of a percent lower interest rate, depending upon the loan program. When does it make sense to pay points? Paying points is a prudent financial move, if you are planning to be in the loan for a long period of time. Again, the question is, How long do you need to borrow this money?
Notice that the question is not geared to, How long do I plan to live in the home? But more appropriately, How long am I likely to be in this LOAN? How long you will be in the loan is not only affected by the tenure that you own the home, but also the probability of seeking a refinance at some point in the future. As a general rule of thumb, you will need to be able to recuperate the total cost of the points in a period of time that is less than the amount of time you will need to borrow the money. Here's an example. Let's say you are going to borrow $300,000 for your mortgage, and choose to pay one point, which equates to an initial up front closing cost of $3,000. If paying one point up front saves you $50 a month, this means it will take you 60 months or 5 years, to recuperate the cost of the point that you paid. If you refinance the home anytime before that 60 month mark, or decide to sell the home, you will have effectively wasted money. However, if you stay in the home for longer than a 60−month period of time, it is a prudent financial move.
When deciding whether or not you should pay points, take into consideration where interest rates are at when you seek financing, and compare that to historical market trends.
When interest rates are at historical lows, it makes much more sense to pay points, especially if you think you will live in the property for an extended period of time. Historically low rates, combined with the fact that you know you do not intend to move would indicate you will have longevity in the loan. It is unlikely rates will go down, giving you incentive to refinance.
When interest rates are higher and off their historical lows, there is a strong likelihood rates will eventually come down because interest rates are cyclical. This is certainly no time to pay points. The chances of refinancing at some point in the future are extremely high, and therefore, you would not need to be in this loan for a long period of time.
It is of utmost importance to work with an experienced loan consultant that understands some of the practical aspects of financial planning. A well versed consultant will ask you many questions about your short and long-term goals, and assist you in choosing a loan program which includes the Points versus No Points question so that your loan is truly suited to your needs.
Derek Egeberg is affiliated with Nova Home Loans, a Licensed Broker #0902429. For a free copy of our “Home Buyers Handbook” send an email to dereke@novahomeloans.com and an electronic copy will be emailed to you. For a FREE printed copy stop by the Nova Home Loans office located at 1730 S. 4th Ave Suite B.
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