We are often asked whether it makes sense to pay points for a lower interest rate.
When a lender locks the interest rate for you, there are a number of different rates available. The lowest rate that doesn’t cost you money is known as the “par” rate. Any rate lower than the par rate is going to cost you money to get. Paying money for a lower rate is known as “paying points”.
As an example, if the par rate happens to be 4.25%, but the borrower would like to get a lower rate (say 4.125%), they can do that, but it’s going to cost them some money for the lower rate. The amount they have to pay depends on how the mortgage bond market is trading when they decide to lock the rate. Sometimes, it only costs a small amount of money to get a lower rate, but other times, it costs a lot of money to get a lower rate. The way to decide whether it makes sense to pay money for a lower rate is to divide the amount of money it costs by the amount of money you are saving each month with the lower rate.
If it costs you $500 to get a rate that is 0.125% lower, and you will save $20 each month by getting that lower rate, divide $500 (the cost) by $20 (the savings), and you get 25, which is the number of months that it will take you to get your money back. If you keep the mortgage for longer than 25 months (a little more than 2 years), it would make sense to pay the $500 for the lower rate.
On the other hand, if it costs you $2000 to lower the rate by 0.125%, and you are only saving $20 each month with the lower rate, it doesn’t make sense to pay points for a lower rate. $2000 divided by $20 = 100 months. That’s a long time to get your money back – probably not a good decision.
Call me now to find your dream home before interest rates go up.