Mortgage Confidential: Paying points

Mortgage expert David Reed invites Walletpop readers to ask him questions about real estate financing. leave your questions in the comment section of this post.

Discount Points, or simply "points," is another of the slough of terms rarely heard outside the home loan process. Do you think lenders just make up all those foreign terms to try and confuse us? Possibly. Even so, this particular term deserves some attention because it affects what your monthly payments will be on your new mortgage.

A point represents 1% of your loan amount. For a loan amount of $250,000 one point would equal $2,500. A point is sometimes called a discount point because the point is used to discount your interest rate that you use to calculate your mortgage payment. How much does it discount your rate?

One point will typically reduce your mortgage rate by 1/4%. If your rate today is 6.00% then your lender would also offer 5.75% if you paid one point. Two points would reduce your rate by 1/2%. And you have choices as to whether or not to pay a point, more than one point or no points at all. It's up to you. So how do you decide whether or not to pay points? Simply take the difference in monthly payment the lower rate provides and divide that into how much your point(s) cost you. The answer is the number of months it would take to "recover" the cost of the point you paid to get the lower rate.

For example, a 30 year fixed rate at 6.00% on $250,000 gives you a $1,499 monthly payment. Paying one point, or $2,500, drops the rate to 5.75% and a $1,459 payment, or a difference of $40 per month. Divide $40 into the $2,500 point you paid and the answer is 62.5. As long as you will keep the mortgage for 62.5 months it would make sense to pay a point to reduce the rate. Over the life of the loan savings? By paying one point you would save $14,400 in interest. Not a bad trade-off.

Real estate finance expert David Reed is president of CD REED Mortgage Bankers in Austin, TX and author of Mortgage Confidential: What You Need to Know That Your Lender Won't Tell You and Mortgages 101: Quick Answers to over 250 Critical Questions About Your Home Loan.
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