When it comes to mortgages, many people tend to look at points and interest rates as to separate issues. In fact, they can almost always be used as leverage against each other.
Points and Interest Rates
Two critical components of a home loan are the interest rate and points charged at the outset. The interest rate is simply the cost of borrowing the money and applies to the total amount borrowed, to wit, six percent for example. The points on a home loan are an up-front fee that equates to a percentage of the loan. For instance, one point equates to an up-front fee equal to one percent of the total loan value. Paying one point on a $300,000 loan would equate to a fee of $3,000.
Many people jump to the conclusion that points are bad and should be avoided at all costs. While this may seem like common sense, it is not true in all situations. From the lender’s view point, points and interest rates work hand in hand. If you have a unique cash situation, you may be able to save a ton of interest over the life of a loan by paying increased points at the outset of the loan. Generally, the more you pay in points, the lower the interest rate on the loan.
If you intend to hold onto your property for a long time, paying maximum points on the mortgage makes sense if you have the cash. The reason for this is the money spent on the points will be easily recovered if you can reduce the interest rate by a full percentage point or more. Saving even one percent on an interest rate will save you tens of thousands of dollars in interest payments on a thirty year loan. In such a situation, it makes sense to pay $6,000 or so in point to save $30,000 or $40,000 in future interest payments. Of course, you have to have the cash available to do it.
If you intend to hold onto a home for a short period of time, the same issues need to be considered. In this case, however, you will not have time to recover any money paid in points because you intend to sell in a few years. As a result, you want to shop for a loan that requires no points be paid. Yes, you will have to accept a higher interest rate on the loan, but this should be somewhat immaterial if you are only buying for the short term.
The bigger point is points and interest rates should be viewed as connected parts of a mortgage. As a borrower, you can negotiate with lenders to raise or lower either one by tweaking the other.