Points (what am I missing)
Can someone explain why lenders tell me that one point (at, say $3000) saving $20 on each mortgage payment will pay for itself in 7 years? By my math, I’d need 12 years before that point starts paying off. Here’s my math: c = the cost of one point s = savings on monthly payment…
Can someone explain why lenders tell me that one point (at, say $3000) saving $20 on each mortgage payment will pay for itself in 7 years? By my math, I’d need 12 years before that point starts paying off.
Here’s my math:
c = the cost of one point
s = savings on monthly payment
12 = months in a year
y = time to break even
y=(c/s)/12
So on a 300,000 loan, if a point takes you from 6.8% to 6.7%, you’re looking at a difference in mortgage payments of $19.94. It will take you 150.44 payments before you’ve paid back your original $3000 investment. That magic point comes after 12.5 years.
Or is my math way off?
Is there some other magic to that equation?
I’m not taking into account lost interest on that $3000, but that would only stretch out the time you’d have to hold a mortgage to see any advantage, right?
PS. If I’m being dense, please do try to be nice about it.
Short answer for amanda:
Don’t take the deal with points. As you stated it, a lender offering 6.5% no points or 6.375 with 1 point. Rule of thumb from Kenneth “If you pay one point, you should be able to lower your interest rate by a minimum of .25%” and the lender is only lowering by .125%.
If 1 point lowered by .25%, you’d have a break even in year 6.
With 1 point lowering only by .125% your monthly payment only goes down 5 bucks and change (comparing the loan with points to the loan with no points where you put the $3k you save in points toward the down payment) and your break even, taking into account total payments made and remaining loan principle balance, doesn’t happen until the 16th year. It’s unlikely you know you won’t move or want to refinance for 16 years.
I am a very high integrity Chartered Financial Analyst “C.F.A.” bound by a very strict Code of Conduct and Business ethics. I also hav an M.B.A in Finance form N.Y.U. with distinction ( Class of 1984) and over 30 years of experience in corporate financing and investment banking. I have been a Mortgage Broker for the last six years, currently an SVP for Exclusive Capital Consultants based in New York City. General rule of thumb on paying points is as follws: If you pay one point, you should be able to lower your interest rate by a minimum of .25%. With my clients, i always provide them with a breakeven analysis to determine how many months it will take to recoup the cost of the point or points being paid. If you are going to live in the house for at least 10 years, you should look to be able to recoup the cost of the point in approximately 4 to 5 years.
Kenneth Biegen, C.F.A.
Senior Vice President
Exclusive capital Consultants
54 W.21st Street Suite 707
New York, NY 10010
212-485-1600 x 106
cell: 631-834-7343
ken@eccny.net
Banks are required to do some math for you and give you the APR — which is the effective interest you’re paying to finance a smaller amount of money after they take the points (and fees) off the top.
To take the WaMu CD calculations out of the picture, compare the 300k mortgage with 1 discount point to a 297k mortgage with no points. Figuring it this way, you’re better off to avoid points if you can, because your monthly payment is barely lower with points, and your principle balance is higher with points through the majority of the loan term, so you only get a real advantage if you never move or refinance.
You can run numbers w/ online calculators:
http://www.dinkytown.net/java/MortgagePoints.html
Amanda, you can rally make yourself nuts on this one. If you are going to throw in the 10-year CD earnings, then throw in the taxes you will pay on it. Then add back in the other equation the tax savings you will receive when you deduct the $3000 you pay in points, not to mention the extra equity you’ve paid yourself over the time period as BW points out above. You just need to get to a ballpark on this one.
Are you really only getting 1/8 lower in return for a whole point? That does seem like it would take a while to pay off.
Thanks Chas. Those are made up numbers for the purpose of an example. I think we’ve been told 6.8 -> 6.675 or 6.5 -> 6.375 (two different lenders, duh).
Now I just want a formula for including some interest.
It seems like a person can get a 10 year CD at 5% (at least at WaMu) Using Moneychimp’s calculator (http://www.moneychimp.com/calculator/compound_interest_calculator.htm)
it seems like if that $3000 were invested instead in a 10 year CD, it’d be worth $4,886.68 at the end of that period. Assuming your interest is compounded annually, which may or may not be accurate. At $19.94/month it will take more like 20 years to break even on your $3000 if you look at the lost interest. But if, after 10 years you reinvest that money … you can see where I’m going with this.
Thanks Chas.
I think you are spot on, by month 84 by my calculation, you have saved approximately $1,675 in mortgage payments. However, at month 84, given the lower interest rate, you have a balance on your mortage (at 6.7%) that is c. $875 lower, so all in you are close to a $2,550 different from a net worth perspective.
Hope this helps and hope I am right
If you are pre-paying 1 full point (1% of loan amount)to lower your rate, you should be getting a bigger reduction in interest rate than .1% that you are showing (perhaps closer to .25% – .35%). For the rest, math seems right.