In order to get a lower monthly payment lenders will give the borrower the opportunity to pay an up front fee which lowers the interest rate thus, paying less on their month to month housing note.
A good online mortgage calculator will do all the computation and analysis for you but we’ll explain it for you below….
Here’s how it works:
The up front fee is called “points”. You typically pay 1% of the amount borrowed for each point:
Let’s illustrate:
If the amount borrowed was $100,000 then 1 point would cost you $1000 ( $100,000 x 1%) This in turn will lower, or "buy down" your interest rate by .25%. For example, if you only qualify for a 6.75% mortgage rate on a $100,000 loan, paying your broker $1000.00 up front can reduce the rate to 6.5%.
Determining if this is a wise move finacially for your family depends on a few factors, mainly the length of time you are planning on staying in the home. Again, a good online mortgage calculator will compare the loan with and with out points. (The online mortgage calculator will ask you for principal, interest rate and number of points)
In another example borrowing $100,000 for 30 years at 6.75% with no points would result in a payment of $648 monthly ( Principal and interest only… no tax or insurance in this example)
The same loan but charging the borrower 2 points :
- drops the interest rate to 6.25%
- lowers the monthly payment to $615.00 monthly
- save $11,880 in total interest repayment
The above scenario makes sense if you plan on stayng in the home for at least 5 years ( break even point).
Again a good online mortgage calculator will clearly let you compare a loan with points and without points so you can determine:
- total interest saved
- How many years break even
Break Even Point …Huh?
The break even point is the number of years it takes to re-coup the expense of paying for the points upfront. To get a financial benefit from buying down your interest rate by purchasing points you need to stay in your house until after the total of the monthly savings realized is greater than the total amount of cash dished out on points.
To Illustrate...
The cost for 2 points above was $2000. Each month you save 33 bucks because you lowered your interest rate. So… $2000/$33 = 125 ( payments or months) which is about 5 years
After about 5 years you’ve paid back all the cost of the points which now gives you the opportunity to avoid $11,880 in interest had you not purchased points.
So, points are not always bad if you want to lower your interest rate, It really depends on how long you plan on staying in your home and how much cash you have at the time of closing.
For 15 years Leslie Collins has been helping all types of borrowers get the loan information they need to make the best home buying decision . Please visit the easy to use mortgage calculator before you talk to banks or loan officers. Also see our easy online mortgage application safe, secure and takes about 2 minutes!
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