Points. What Are They in Should I Pay Them?

We are currently seeing interest rates at a roughly 50 year low. That makes it extremely good for a buyer because due to the low interest rate a buyer can now qualify for a larger loan or enjoy the benefits of a smaller loan payment due to the reduced interest rate. In spite of the wonderful benefit afforded by the currently low rates, perhaps you would like to have your Durango real estate purchase be more attractive with an even lower interest rate? It all has to do with points; so let me explain.

When a buyer takes out a home loan, often times the lender will ask that they pay a "point". The money goes to the lender to increase the yield on the loan. One point is defined as one percent of the loan amount... not one percent of the purchase price. A $100,000 sales price with a $20,000 down payment would result in a loan of $80,000. If the buyer paid one point, that would equal $800. Sometimes you hear loan rates quoted as X% with a 2% loan origination fee (LOF). For purposes of this discussion, points and loan origination fees are the same thing.

How are points useful? Let's say you have been preapproved for a 6% loan in the amount of $200,000. That would require a payment of $1200 per month. Remember it is the monthly payment amount that the bank uses in qualifying a borrower, not the gross amount of the loan. If the borrower has the cash to pay a point (or sometimes we can get a seller to pay it on behalf of the buyer) then that cash payment "buys down" the interest rate on the loan to a lower level. With a lower rate, the payment comes down or it will allow the borrower to qualify for a larger loan. Using our example above, let's say we paid one point. The rate would drop to 5.75% which would allow the borrower to get a loan for $205,475. If 2 points were paid, that would increase the loan amount to $211,187. That larger borrowing ability could be very useful in buying just the right home.

Should I pay points or not? It is a question I often hear and I always answer and say this: "Paying points is a math problem." Again, using our example from above, if one point is paid that would amount to $2000. If taken as a decreased interest rate, the payment would go from $1200 a month to $1167 per month a savings of $33 per month. Hence, it would take 60.6 months for the borrower to recoup their $2000. So the question to be asked is this: "Do I feel comfortable that I'm going to live in this house for at least 60.6 months?" If the answer is yes then you should seriously consider the option of paying the points.

By these two examples you can see there are two reasons to pay points: (1) to allow you to qualify for a larger loan or (2) to lower your monthly payment. If you need assistance in buying a property in the Durango area please give us a call and a Team member will be more than happy to help you with this type of calculation.