Points (real estate)
Points are a form of pre-paid
interest. One point equals one percent of the loanamount. By charging a borrower points, a lender effectively increases the yield on the loan above the amount of the stated interest rate. Borrowers can offer to pay a lender points as a method to reduce the interest rate on the loan, thus obtaining a lower monthly payment in exchange for this up-front payment.
Paying Points represent a calculated gamble on the part of the buyer. There will be a specific point in the timeline of the loan where the monies spent to buy down the interest rate will be equal to the monies saved by making reduced loan payments resulting from the lower interest rate on the loan.
Selling the property or refinancing prior to this break-even point will result in a net financial loss for the buyer while keeping the loan for longer than this break-even point will result in a net financial savings for the buyer. The longer you keep the property financed under the loan with purchased points, the more the monies spent on the points will pay off. Accordingly, If the intention is to buy and sell the property or re-finance in a rapid fashion, buying points is actually going to end up costing more than just paying the loan at the higher interest rate.
MonthlyPmtWithoutPurchasedPoints - MonthlyPmtWithPurchasedPoints = MonthlyPointsSavings
CostOfPurchasedPoints / MonthlyPointsSavings = NumberOfMonthsToBreakEvenPoint
NumberOfMonthsToBreakEvenPoint / 12 = NumberOfYearsToBreakEvenPoint
As stated, The decision to buy points based on a financial savings point of view should be based on the intended duration of the loan. Selling or refinancing prior to the break-even point render the purchase of points counter productive.
NOTE: Another perfectly valid application for the purchasing of Points is to reduce the monthly payment for the purpose of QUALIFYING for the loan. Loan qualification based on monthly income versus the monthly loan payment may sometimes only be achievable by reducing the monthly payment through the purchasing of points to buy down the interest rate thereby reducing the monthly loan payment.
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