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The basics of discount points

August 06, 2007

Discount points are paid up front to obtain a lower interest rate on your mortgage. The more points you pay the lower the rate you obtain. Typically, one point equals one percent of the loan amount and will lower the interest rate by .25 percent.

Pro: Paying points may be advantageous if you intend to hold the property for a long time.

Con: If you intend to hold the mortgage for a short period of time, the cost you pay up front may exceed the benefit you'll receive from a lower rate.

To get an idea of whether or not it is worth it to pay points, divide the amount paid in points by the amount saved by the lower monthly payment.

For example: If you are borrowing $100,000 you can pay no points at seven percent interest for 30 years, which is roughly $665 per month. Or you can pay two points for a 6.5 percent rate, which is roughly $632 per month. Your savings per month would be $33 ($665-$632).

The amount you pay for two points would be about $2,000 (one point is one percent of 100,000 or $1,000). Following the formula:

$2,000 (amount paid for points) / $33 (savings per month) = 60.6 months.

60.6 months is how long you would need to keep the house to make paying points worth the cost.

 

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