Think about the value of points when refinancing

There are several things to think about when deciding to refinance. Unless you are refinancing with a home equity loan, chances are you are refinancing to lower your monthly payment.

Most people think about the interest rate they will be paying on when they refinance. Now, the Federal Reserve set the interest rates, but a lender has control to play around with the interest rate.

The mortgagecontent.net article, “Points and Refinancing,” explains how one point can make a big overall difference in your loan.

A point is charged by your lender and is usually due at closing time. One point is equivalent to one percent of the total amount of your loan. For example, one point of a $250,000 loan will cost you $2,500.

“Before you refinance, compare different lenders' rates and points. Usually, a lower rate carries more points. For example, one lender may charge 6.5% interest with no points and another lender may offer 6.375% interest with one point. As a general rule, each point that you pay will reduce the interest rate offered by the lender by about one-eighth of one percent, or 0.125%.”

As a result, you may want to consider paying additional points to lower your interest rate. This technique is referred to as “buying down.” Your lender may also work with you so that you will not have to pay the point upfront but rather extend it to be included in your monthly payments.

You still have to be careful when “buying down” with points; the biggest determining factor of whether to buy points is when you plan on moving. If you move within, say, five years, you probably would not have recovered your upfront losses yet.

“Consider James Morgan, who has a 30-year fixed-rate mortgage loan for $200,000. His loan interest rate is 6.75% with one point and his monthly payment of principal and interest is $1,297.20. If he did not pay the point, his interest rate would be 6.875% and his monthly payment would be $1,313.86. Paying the point saves him $16.66 per month, or roughly $200 per year.”

“In 10 years, James will recoup the point he paid to get the lower rate. Because he will continue to pay lower payments each month after that, James will benefit from the lower rate. Over the life of his 30-year loan, James will save roughly $6,000 in monthly payments due to the lower rate in exchange for the upfront cost of $2,000 for the point. But if he moves after just a few years, he will not recover his costs.”

Points can also be tax deductible with certain stipulations. If you itemize your taxes, you should be able to deduct the point(s) you paid on your refinance loan.

“However, points paid in a refinance transaction usually must be deducted over the life of the loan, rather than as a lump sum in the year they were paid. For example, rather than deducting the entire $2,000 in points that he paid when he refinanced, James Morgan will deduct $5.56 per month for the next 30 years. ($2,000 / 360 monthly payments = $5.56 per month deduction).”

So, if you are looking to save money in the long run, paying an extra point or two on your loan may be a viable and rewarding option.

Yet, most people do not want to pay a couple extra thousand dollars upfront on top of all the other closing costs they will have to pay, so they try to stay away from buying points.

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