When you’re shopping for the lowest refinance rates for your next home loan you’re going to encounter discount points. Is it worthwhile paying points to get the lowest refinance rates? Here are several tips to help you minimize your out-of-pocket expenses and get the maximum benefit from today’s best refinance rates.
Paying discount points will get you lower refinance rates
There are two kinds of points you’re going to encounter refinancing your home. The first is the origination fee also known as origination points. That’s not what I’m talking about here. The second fee is paid to “buy” down your refinance rates, the discount point.
The loan origination fee is a commission paid to the bank or broker arranging your home loan. All of the fees you pay at closing are important because overpaying reduces the benefit you’re getting from a lower payment.
Remember that paying discount points is optional even though the majority of lenders quote refinance rates that include discount points before their zero point offerings.
Do you really even want the lowest refinance rates?
Suppose you’re shopping from the best mortgage lenders for a $250,000 home loan. You’ll find the best mortgage lenders promoting refinance rates with their low, low APR such as 2.99 percent followed by a lot of impossibly small text.
That impossibly fine text includes all of the details about that refinance rate, including the fact that you’ll be required to pay two discount points.
Beware refinance rates that you have to pay for…
In this example the two discount points you’re required to pay are responsible for that amazingly low APR. You also need to know that Annual Percentage Rate or APR is manipulated by lenders with discount points. The home loan with the lowest APR usually has the highest out-of-pocket expenses because you’re required to pay discount points to qualify.
Two mortgage points in this example will cost you $5,000. One discount point is one percent of your loan amount and typically lowers refinance rates by .25 percent. If you opt for this lenders zero point mortgage the refinance rate will be closer to 3.5 percent without paying mortgage discount points.
What does this do to your payment? On a $250,000 30-year fixed mortgage at 2.99% the monthly payment is $1,052. The same 30-year fixed rate mortgage at 3.5% has payments of $1,122. That’s a difference of $70 a month which is costing you five grand out-of-pocket.
Keep in mind that you have to pay the $5,000 on top of all of your other closing costs including the loan origination fee, underwriting, and junk fees like rate lock and processing fees. (Lender junk fees can be avoided…more on this later)
Is saving $840 a year worth five grand? The answer depends on how long it takes you to break even recouping all of your closing costs.
How long to break even recouping your closing costs?
It’s true that getting the lowest refinance rates feels good when writing that check every month…unless you’re actually losing money. Like paying $5,000 out of pocket to save $70 a month only to sell your home two years later.
Another problem with paying discount points is that inflation reduces the benefit of the cash you’re laying out today. You might be reading this today wondering why in the world would anyone want to drop five thousand dollars to save $70 a month?
That’s where your break-even point factors into the equation. Eventually, provided that you don’t sell or start serial refinancing that $70 a month you’re saving is going to recoup your five grand.
The point where you start benefiting from discount points and lower refinance rates is your break-even point. You can approximate your break-even point simply without having to factor your income tax and savings into the equation.
For most people paying discount points when refinancing simply does not make sense.
In our example recouping discount points from the lower payment alone will take 71 months, almost six years and does not include any of your closing costs.
If you’re not planning on keeping your home long enough to break even then paying discount points is a waste of your money. If you plan on keeping the same mortgage for its full term (almost no one does) then paying discount points could save you almost $20,000 over the course of thirty years.
The bottom line for most people is that the less you pay at closing the more benefit you’re get from today’s lowest refinance rates.
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