Should I Pay Points?
The best way to decide whether you should pay points or not is to perform a break-even analysis.
This is done as follows:
There is also this simple, and less precise, rule of thumb: If you plan to stay in the house for less
than 3 years, do not pay points. If you plan to stay in the house for more than 5 years, pay 1 to 2
points. If you plan to stay in the house for between 3 and 5 years, it does not make a significant
difference whether you pay points or not.
Tax Advantages of Paying Points
The above calculation does not take into account the tax advantages of points. When you are
buying a house the points you pay are tax-deductible in the tax year you pay them, so you realize
some savings immediately. On the other hand, when you get a lower payment, your annual income
tax deduction reduces because there is less interest to deduct. This makes it a little difficult to
calculate the break-even time taking taxes into account. In the case of a purchase, the tax
deductibility of any points paid at closing definitely improves the break-even time. However, in the
case of a refinance, the points are NOT tax-deductible, but have to be amortized over the life of the
loan. This results in few tax benefits or none at all, so there is little or no effect on the time to break
even. (While we deem this information to be reliable, as is always the case when it comes to
taxes, please consult with a professional tax adviser.)
One Last Thing To Consider
Let's say you have done all the calculations, you know you'll be in the home for over 5 years, and
you decide to pay points to buy your rate down. But what if rates fall significantly next year? If you
paid $2,000 in points to buy your rate down, and in the next year or so rates fall below the rate you
just bought down, the money previously paid on points may have been wasted. Why? Because not
enough time had elapsed to recover the cost of the points previously paid. This is why we generally
don't recommend paying points. Plus, for the cost of refinancing (equivalent to about 1-2 monthly
payments, which can usually be rolled into the loan), you can always refinance at a later date and
get an even better rate if the market improves..
There's no question, it can be a difficult choice with all the variables to consider. At the end of the
day, if you feel rates may improve during your time in the home, and you can do better things in the
meantime with the money you would spend on points, opt instead for a Zero Point interest rate.
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The best way to decide whether you should pay points or not is to perform a break-even analysis.
This is done as follows:
- Calculate the cost of the points. For Example: 2 points on a $100,000 loan is $2,000.
- Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. For
Example: $50 per month - Divide the cost of the points by the monthly savings to come up with the number of months
to break even. In the above example, this number is 40 months. If you plan to keep the
house for longer than the break-even number of months, then it makes sense to pay
points; otherwise it does not.
There is also this simple, and less precise, rule of thumb: If you plan to stay in the house for less
than 3 years, do not pay points. If you plan to stay in the house for more than 5 years, pay 1 to 2
points. If you plan to stay in the house for between 3 and 5 years, it does not make a significant
difference whether you pay points or not.
Tax Advantages of Paying Points
The above calculation does not take into account the tax advantages of points. When you are
buying a house the points you pay are tax-deductible in the tax year you pay them, so you realize
some savings immediately. On the other hand, when you get a lower payment, your annual income
tax deduction reduces because there is less interest to deduct. This makes it a little difficult to
calculate the break-even time taking taxes into account. In the case of a purchase, the tax
deductibility of any points paid at closing definitely improves the break-even time. However, in the
case of a refinance, the points are NOT tax-deductible, but have to be amortized over the life of the
loan. This results in few tax benefits or none at all, so there is little or no effect on the time to break
even. (While we deem this information to be reliable, as is always the case when it comes to
taxes, please consult with a professional tax adviser.)
One Last Thing To Consider
Let's say you have done all the calculations, you know you'll be in the home for over 5 years, and
you decide to pay points to buy your rate down. But what if rates fall significantly next year? If you
paid $2,000 in points to buy your rate down, and in the next year or so rates fall below the rate you
just bought down, the money previously paid on points may have been wasted. Why? Because not
enough time had elapsed to recover the cost of the points previously paid. This is why we generally
don't recommend paying points. Plus, for the cost of refinancing (equivalent to about 1-2 monthly
payments, which can usually be rolled into the loan), you can always refinance at a later date and
get an even better rate if the market improves..
There's no question, it can be a difficult choice with all the variables to consider. At the end of the
day, if you feel rates may improve during your time in the home, and you can do better things in the
meantime with the money you would spend on points, opt instead for a Zero Point interest rate.
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