What's the point?

What are mortgage loan points? You've heard them talked about, but never really understood what they are? Well, guess no more!

Points are fees that a borrower pays the lender at closing in exchange for a lower rate; think prepaid interest. These points are a percentage of the loan amount. Two points on a $150,000 loan would cost you an additional $3000 in closing costs. So, what's the benefit? That depends. There could be a big benefit, or none at all.

Let's say that you're financing $150,000 for 20 years. You decided that you will pay two points in exchange for a loan rate that is one half a percentage point lower. This means that you're paying $3000 interest in advance for a lower loan rate. How will this benefit you?

A $150,000 loan over 20 years @ 6.75% carries a payment of $1,140. Now lets say that you pay two points, and the rate is lowered to 6.25%. Now the payment is $1,096. So, in exchange for $3000 up front, you save $44.00 per month in payment. You will need to have this mortgage for a minimum of 68 months to break even ($3000 divided by $44.00 = 68). After that, you're actually saving money. Over the life of the loan you would pay about $10,000 less in interest charges by pre-paying $3000 up front. This results in a $7000 savings for you. Is it worth it? That's for you to determine. Here's a nice calculator on Bankrate.com .

You should consider other places that you could invest this money and the tax benefits associated with mortgage interest. You should also consider whether or not it is realistic to expect you will have the same mortgage five years from now. Hope this helps!

BTW- Be sure to check out the latest Carnival of Personal Finance hosted by The Digerati Life!