Paying for points when refinancing does reduce your interest rate, resulting in a lower monthly payment, but doing so may not be your best financial move. Answer the following four questions to see if paying to get a lower interest rate on your mortgage loan will help with your debt.
1. Do you plan to stay in your home for more than five years?
Generally, the cost of a point is equal to 1 percent of your mortgage. So for a $200,000 mortgage, a point would cost $2,000, and buying the point would generally lower your interest rate by a fraction of a percentage point.
In order to determine if what is essentially a prepayment of interest is right for your situation, calculate when you will recoup your payment for the points. This is the future date in the payment schedule when the monthly interest savings equals the amount you paid for the points.
If you find that you won't break even until after you plan on selling the home, paying for points does not work for your situation. If you determine you will still be in your home after the break-even point, then paying points makes sense.
2. Will you save money in taxes?
Mortgage points are generally tax deductible, so paying points may offer tax savings that make the expense advantageous. Consult with your tax advisor to see if paying for points works for your financial situation.
3. Are you getting a fixed-rate mortgage?
Paying for points isn't generally done for an adjustable-rate mortgage, because such loans feature a discount at the beginning of the loan and then later become adjustable.
4. Can you afford the upfront expense?
Are you able to comfortably pay for the points without stretching your budget thin or emptying out your emergency savings account? If the move will add to your financial burden rather than lighten it, avoid paying for points.
When you ask the right questions regarding whether to pay points to get a lower interest rate, you can be assured that you're doing all you can to achieve debt reduction.
About the Author:
Julie Bawden-Davis is a Southern-California-based writer specializing in personal finance and insurance. Since 1983, her work has appeared in a wide variety of publications, including Family Circle, Ladies' Home Journal, Parenting, Entrepreneur and The Los Angeles Times.