Everyone is familiar with the term “paying points“, but do we really know what this is and the different effects it can have on a mortgage loan? Traditionally, this means paying 1 percent of the dollar of the loan amount in order to get a lower rate. This is commonly referred to as “buying down the rate“.

Here is an example. The Jones’ family purchases a home for $300,000 and puts 20% down. The loan balance is $240,000. The current rate on a 30 year fixed loan is 6.25%. Financing $240,000 for 30 years at a fixed rate of 6.25% makes a payment of $1,477 (principle and interest). Suppose the clients decide to “buy down the rate”. In this scenario, paying .00625 of the loan balance upfront ($1,500) will lower the interest rate by 1/8th of 1%. The payment is now $1,458, a decrease of $21. Quickly dividing the $1,500 by $21/month gives us a breakeven point of just under 6 years.

Translation: If you think you will stay in the house more than 6 years, it is worth paying points. This assumes you have the cash and are willing to spend it this way. Another option would be to pay 1.25% of the loan amount ($3,000) upfront to lower the rate by ¼%. This has the same payback period as the first option, but it requires twice the cash out of pocket as well as lowering your payment by twice the dollar amount on a monthly basis ($42).

The opposite of this is taking a slightly higher interest rate in order to pay your closing costs. In this scenario using the same $300,000 selling price, the client has just enough money to put 20 percent down but not the closing costs. (FYI, putting 20 percent down allows the client to avoid paying mortgage insurance. This insurance protects the lender in the case of foreclosure if the amount the lender receives from the sale of the property is less than the balance of the loan.) Anyhow, instead of 6.25% interest, the client elects to accept 6.5% interest.. In this scenario, this would allow the mortgage company to rebate roughly the amount of all of the closing costs and prepaid items to the seller as a credit on the settlement statement, thus saving precious “cash out of pocket”!

These are just a two examples of what can be done to save money or reduce the buyer’s cash investment when a home is purchased. Paying points can be a good way to reduce your monthly payments and for folks who have less cash to put into a transaction, getting the mortgage broker or the seller to pay closing costs can sometimes make the difference between making a deal or not. I recommend speaking with your mortgage professional in order to find out exactly what options are available and what makes the most sense for you.

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Patrick Randles is a guest contributor to Tucson REblog and gives an insider’s view on the mortgage industry. He is a Mortgage Loan Consultant with El Conquistador Mortgage in Tucson, Arizona. Patrick can be contacted by phone (520-850-7485) or email. Feel free to post any questions for Patrick!

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