Pre-paying points on your mortgage loan to get a lower interest rate is great if you can afford it, but what if you don?t have the cash? Is it always best to pre-pay interest with points?
There are situations where pre-paying points is not the best thing to do. Points, called “origination fees” or “discount points” are equal to one percent of your total mortgage amount paid at the closing table. When you pre-pay points on the loan you are paying up front to get a lower interest rate. The more points you buy, the better your interest rate should be. Points came about in the 80s when interest rates were 15 percent and higher. This was a way to help people purchase homes in the stagnant housing market of the day. Mortgage lenders offered discounted loans for homeowners that could put down the cash for pre-paid interest.
Today’s marketplace is very different. Interest rates are still at historically low levels. Today you can finance a $400,000 home for as little as 6%. The market place is extremely competitive and mortgage lenders are fighting each other for your business; as a result you don?t need to drop all your cash at the closing table to get a decent interest rate.
For example, if you were to take out a 30 year fixed-interest rate mortgage at 6.5 percent and pre-pay 2 points on a $200,000 home you would have to pay $4,000 at closing. If another lender is offering you the same loan at 7 percent with zero points which mortgage loan is the best deal?
Assuming that you have 20 percent down the payment each month for the first loan is $1,264. Since this loan has a fixed interest rate the payment will not change for entire duration of the loan. While the interest rate you are getting is 6.5%, you have to fork over four thousand dollars to close.
The second loan is a 7 percent offer with zero points due at closing. At 7 percent your monthly payment goes up to $1,330; your monthly payment is $66 more per month. To compare the savings divide $4,000 in pre-paid interest by $66 and you?ll see it takes 60 months (five years) to realize the savings. If you invested that same $4,000 at a modest return you could earn more that what you save by pre-paying points.
By prepaying points on your mortgage loan you would have to live in your home for six years before realizing any savings from your money. If you move during the first five years you?ve effectively wasted your money. As you can see points may not be the best way to secure a lower interest rate for your mortgage loan.
You can learn more about saving money on your next mortgage by checking out my free Underground Mortgage Videos.