Refinancing a Home: Are Points a Rip-off?

If you're considering refinancing a home, you'll soon see that there's a relationship between the amount you're willing to pay and the rate that you get. While comparing refinance rates online, you find a refinance rate that compares very favorably with yours, but then there's a catch -- you have to pay upfront mortgage "points" to get that rate.

Is this a little like a used car salesman's trick of introducing a hidden fee just when you think you have a deal? No, not really. Points can confuse comparisons between mortgages, but they are considered a legitimate component of how a loan can be structured. A loan with points may turn out to be your best deal, but first you need to know how to make comparisons between mortgages more meaningful.

What's the Point of Points?

A mortgage point is an amount equal to one percent of the loan amount. It is an upfront charge that covers the cost of originating the loan (in this case it's called an "origination fee") or to lower the interest rate (in that case it's called a "discount point").

The difficulty is that because fees, points, and interest rates can be somewhat interchangeable, loans with different structures can be harder to compare. You may see one loan that has the lowest interest rate, but a high loan origination fee. A second may have a slightly higher interest rate, but a more reasonable origination fee. A third might have a similar interest rate to the second loan and a lower origination fee, but require you to pay discount points.

However, at the end of the day, loan costs are loan costs, and it doesn't matter if they are called "underwriting fees," "mortgage origination charges," "discount points," or "hamburgers." To make sense of all this so you can compare loans in a meaningful way, you need to do two things. First, decide on your primary objective in refinancing the loan, and second, compare each loan's total cost- - interest, fees, and points -- on a level playing field.

Should You Pay points When Refinancing a Home?

Here is how you work through the process of making meaningful comparisons of refinancing options:

Decide on your refinancing objective. If you are refinancing because your budget is tight and you need to lower your payments ASAP, paying points may make sense if you can roll them into your refinance loan. You won't be paying for them upfront, but buying down your rate and payment may get you the breathing room you're looking for. If you can't roll them in, anything that causes you to pay more upfront is counterproductive if you're already cash-strapped.

Paying points upfront may also be counterproductive if the point of refinancing is to take cash out for home improvement or other projects. Using a refinance breakeven calculator can tell you how much your new payment would be, how long it will take for your monthly savings to cover the costs of refinancing, and how much the loan will cost over its lifetime.

How do the APRs compare? If you can afford to pay upfront points, then the question becomes one of whether paying points would lower your costs in the long run. To do this, you need to compare each loan's Annual Percentage Rate, or APR. APR calculations include the interest and the costs of getting the loan. Mortgage lenders are required by law to disclose the APR any time they advertise an interest rate. However, lenders don't all calculate the APR in exactly the same way – small variations between lender offers may not be significant.

In short, there is nothing wrong with paying points if the upfront cost is not a barrier to refinancing a home, and if they enable you to get the best deal overall. You just need to put everything into APR terms to see if there really is a point in paying those points.

Use LendingTree's refinance break-even calculator. APRs are calculated based on the assumption that you'll keep the loan for its entire term. If you refinance or sell your home before that (as most people do), the figures become very distorted.

Imagine that you have a $100,000 refinance loan and you're comparing mortgage quotes. One loan has an interest rate of 4.0 percent, a $477 payment, an APR of 4.083 and total loan costs of $1,000. Another loan has an interest rate of 3.65 percent, a $457 payment, and APR of 4.051 percent and loan costs of $5,000.

At first, the second loan looks like the better deal. Its APR and monthly payment are lower. However, the second loan has a lot of upfront costs to recover. It would take over 15 years for the $20 a month difference in payment to offset the extra $4,000 in upfront costs.

APR is a useful tool because it helps consumers compare loans that can have very different rate and cost structures. But APR is only one thing to consider – to really see if you should pay points, compare costs and use a refinance breakeven calculator.

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