PHILADELPHLA - This isn't really the height of home-buying season, but with interest rates remaining low you may be thinking about buying, or refinancing.
The mortgage ads can be bewildering. There are loans with zero points, one point, two, three - even odd numbers like 2.88. And each has a different interest rate.
What's the best deal?
Basically, points are interest that's paid up front, as
opposed to interest paid each month with the mortgage
payments. Each point equals 1 percent of the loan - on a
$100,000 loan, three points, come to $3,000.
If you pay the points up front, you're rewarded with a slightly lower interest rate on the loan, since the lender gets to reinvest all that money immediately
Generally, paying points is more likely to pay off if you expect to be in the house for many years How long? As long as it takes for your monthly savings from the lower interest rate to equal what you pay in points to get the lower rate.
For example, consider an ad that offered two deals on a 30 years, fixed-rate loan: 6.875
percent with three points, or 7.6 percent with no points.
For a $100,000 mortgage, the monthly payment on the three-point loan would be $657. On the zero-point loan it would be $706. It would take about 61 months for the $49 savings on the three-point loan to pay off the $3,000 paid to get the lower interest rate.
So, if you'll own the house longer than that, you'd save money by paying points.
But what if you sold the house in three years? You'd have paid $3,000 in points so save only $1,764 in monthly payments. Not good.
To refine the calculation, consider the tax implications. The extra $49 you'd pay on the zero-point loan is interest that's deductible on your federal income taxes. If you're in the 28 percent bracket, you'd get back $13.72 of the $49 So the extra cost of the zero-point mortgage is actually $35.28 per month - meaning you save only $35.28 a month by getting a three-point mortgage. It will take a about 85 months - seven years - for $35 28 a month to pay off the $3,000 in points In the long run, you're still better off paying points.
There's another wrinkle to consider. If you're taking
out a mortgage because you're buying the house rather than
refinancing, all three points are deductible on your federal
income tax for the year you buy the house. So, if you're in a 28
percent tax bracket, you'd deduct $3,000 from your income and
save $840 in taxes. The real cost of paying the points, thus, is
only $2,160, and your $49-per-month saving pays off the points
in only 44 months. (If you assume a $35.28 monthly savings,
the $2,160 is paid off in 61 months.)
But if you are "refinancing" your mortgage, you cannot
deduct all the points immediately; you have to spread them out
over the life of the loan. Each year, you could deduct 1/30th of
$3,000 - or $100.
Now, to be even more precise, factor in what you'd
make if you invested the three points or the monthly savings.
If you got the zero-point mortgage, and invested the
$3,000 saved at an annual return of 8 percent, you'd have
$4,408 after 5 years, $6,477 after 10 and $30,188 after 30.
If you paid the points and invested the $49 you saved
each month, earning 8 percent, you'd have $3,574 after five
years - less than you'd have investing the $3,000 lump sum. But
over longer periods, the $49-per-month investment would
overtake the $3,000 one, growing to $8,826 after 10 years and a
whopping $69,019 after 30.
Once again, in the short term you come out ahead
by not paying points, but over the long haul you're better off
with the lower interest rate you get by paying points.
But be sure to figure the numbers yourself, since the break-even
point will change if you use different interest rates.
