For those who have financed a home before, either for a purchase or refinance, the first time around they might have been surprised at all the options available to them. First, they must decide between a fixed rate and an adjustable rate mortgage.
After that determination is made they must also consider the loan term. Most terms range from 10 to 30 years in five-year increments. Once that is settled, they’re faced with deciding on which interest rate within that particular loan program they should choose.
Interest rate selections will vary based on whether or not you pay points for that rate. A point, often referred to by lenders as a “discount point” is expressed as a percentage of the loan amount. For a $650,000 jumbo loan, one point (1%) is $6,500. Paying points lowers the rate for the life of the loan. Because points are considered prepaid interest to the lender, it may be tax deductible just as standard mortgage interest is tax deductible. So how do you decide if you should pay points and if so, how much should you pay?
Let’s look again at that $650,000 loan amount. You speak with your loan officer and are told there are several options and two of them are to pay one point for a lower rate and one rate without any points. The rate without a point is quoted at 4.25% on a 30-year loan. The payment works out to $3,197 per month.
Next, your loan officer quotes you a rate with paying one point at closing, or $6,500. The payment where the rate is 0.25% lower, or 4.00%, yields a monthly payment of $3,103 for a difference of $94 per month. Not bad, but on a jumbo loan amount of $650,000 that’s not much of a difference in this example. If you divided the $6,500 by the monthly savings of $94 it would take just over 69 months to break even. That seems like a long time but this is the math you and your loan officer will work out together.
*Tip: It’s not uncommon for buyers to assume the amount they pay in points, reduces their interest rate by the same amount. That’s not the case, in a normal situation buyers see about .25% reduction in interest rate for every 1% (1 point) paid.
Now consider the very same scenario except let’s change the term from 30 to 15 years and see what we get. If a 15 year rate at 4.00% on a $650,000 is the choice with no points, the payment is $4,807. Paying for a discount point of $6,500 might lower the rate to 3.75% which results in a monthly payment of $4,726 for a difference of $81. $6,500 divided by $81 means the breakeven point is further out still at 80 months, or close to half the term of the 15 year loan.
Now let’s reverse this and look at not just paying no points but selecting a rate slightly higher and receiving a lender credit toward your closing costs. If we again look at the 15 year loan term and a 4.00% rate with no points, let’s increase the rate to say 4.375%. A 15 year loan at 4.375% provides a monthly payment of $4,931, or $124 higher. However, now the lender can provide you with a lender credit equal to one point, or $6,500. Your monthly payment will be higher but you saved $6,500 in closing costs.
What option make the most sense for you will depend on many factors like loan program, term and most importantly… time. If you are planning on living in your new home forever and have the money, paying point(s) may not be a bad idea. However, if you plan to live in your house only 1-7 years, it’s unlikely paying points will provide much financial benefit.
Qualified home buyers in Maryland have an assortment of Jumbo loan options with only 5% and 10% down payment. These low down payment Jumbo options are especially popular in more expensive locations like Baltimore, Towson, Annapolis, etc. Buyers can read more about all the Jumbo loan requirements here. Questions? Just submit the Request Contact form above to be connected to a loan specialist today.
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