The Loan Lady Blog

Origination points are often misunderstood. Points are nothing other than interest paid at the time of closing to obtain a lower interest rate on a loan. One point is equivalent to 1% of the loan amount. If you are going to borrow $450,000 on your loan, one point would equal $4,500. This generally  generates 1/8 to 3/8 of a percent lower interest rate, depending upon the loan program.

When does it make sense to pay points? Paying points is a smart financial move, if you are planning to be in the loan for a long period of time. As a general rule of thumb, you will need to be able to recuperate the total cost of the points in a period of time that is less than the amount of time you will need to borrow the money.

As an example, let's say you are going to borrow $450,000 for your mortgage, and choose to pay one point, which equates to an initial up front cost of $4,500. If paying one point up front saves you $150 a month, this means it will take you 30 months or 2.5 years, to recover the cost of the point that you paid. If you refinance the home anytime before that 30-month mark, or decide to sell the home, you will have effectively wasted money. However, if you keep that loan for longer than a 30-month period of time, it is a smart financial move.

When deciding whether or not you should pay points, take into consideration what interest rates are when you seek financing, and compare that to historical market trends. When interest rates are at historical lows, it makes much more sense to pay points, especially if you think you will live in the property for an extended period of time. Historically low rates, combined with the fact that you know you do not intend to move would indicate you will have the loan for a long time. It is unlikely rates will go down farther, giving you incentive to refinance. Rates are cyclical. When interest rates are off of their historical lows, and higher than they generally are, we know that there is a strong likelihood rates will eventually come down. This is certainly no time to pay points. The chances of refinancing at some point in the future are extremely high, and therefore, you would not need to be in this loan for a long period of time.