Why Pay Points?

There is a whole series of articles on the subject of points because many, many borrowers miss out on the opportunity to save money on their mortgage with points, whether these are positive points or negative points.

You will learn here why paying points is so often a good idea and get a few examples of when points will work in your favor and you will end up paying less to the bank than the average borrower.

About The Average Borrower
Before looking at paying or not paying points, it is very important to understand the concept of the average borrower that the bank uses in determining points and why most borrowers just don't fit the "average borrower" scenario.

Please read about the average borrower on the points - definitions and simple examples page.

So, Why Pay the Points?
Because they save you money. Because the one thing in your control during the mortgage transaction is the points and whether you pay them or not.

When you sign for a mortgage you get the interest rate that the bank offers you based on your credit, your loan amount, the equity you have or the amount you put down. You have no control over these things. Sure, you can shop for a little better deal here or there, but basically they will all be close to the same deal. The only decision is do I take the mortgage, yes or no?

Points give you a little more control over how the mortgage transaction works out over the length of your loan and when properly arranged will always end up putting you in the group that is above average and pays less for their their mortgage loan than an average borrower.

Thanks to the technology and automation in the banking world today, each and every loan is not looked at individually other than whether the borrower will qualify or not. This is an advantage for the savvy borrower with a good mortgage professional to work with.

If every loan were looked at individually and given a separate offer on points, there would be no advantage to points because the bank would make the points fit the loan. They do not do that and this creates a situation which can be taken advantage of.

That is why you pay points. With a mortgage, you pay and pay and pay and pay the bank or mortgage company for this loan. This is your one chance to make those payments a little smaller.

The different ways to do this and how to pay points are in the other articles. But before getting to the how's, let's discuss the fear people have of paying points.

Why many Borrowers are afraid to pay Points
Too many borrowers are so concerned about getting the lowest rate at the lowest cost that they miss a fantastic opportunity. I cannot stress enough that this is not always the best deal.

It all comes down to cost and this short term view of cost makes many borrowers miss the savings they could be putting in their pockets over the length of their mortgage loan.

The true cost of a mortgage is the total cost of what you pay for the entire time you have the loan, NOT what it cost you the day you signed the papers for that mortgage.

The True Cost
If you were applying for a mortgage for $200,000 and I told you that over the next 30 years you will pay a 5.5% interest rate and over the 30 years that you would pay a total of $208,808.80 in interest, you would shake your head at the amount of interest but accept that this is how it works.

Now if the bank were to say to you, if you will pay $2,000 of that interest up front at the closing, we will make you a deal and take $11,000 of interest off the total, would you like to take that option?

What would you say then? It sounds simpler this way, but this really is what paying points does. The bank makes this offer because in their experience the average borrower will never take advantage of the full $11,000 in savings. In fact, the bank knows that the average borrower will barely get the $2,000 back or they would never make the offer.

It is exactly this "average" thinking by the bank that can be taken advantage of with points. If you know you will stay longer than the "average" borrower, you can take advantage of this situation to pay the bank less than you would have without the points.

The secret in making this decision is first off in knowing approximately how long you will stay and secondly in what you really are getting for the points and the choices you have.

The following show exactly how this works for two different borrowers, one who says no to the deal and one who says yes.


An Example of Two Borrowers
Here is a simple example of two borrowers to make this point. Both borrowers get a $200,000 mortgage and keep it for 10 years before selling the home and both borrowers had closing costs of $2,000.

Now, Joe Borrower is the guy who wants the lowest rate at the lowest costs, so he does not pay any points. This is the guy you meet that tells you "I got 5.5% on my mortgage and it was only $2,000!"

On the other hand, we have the truly smart Harry Borrower who paid one point at closing and got 5.25% on his mortgage. When he meets Joe at the party he just nods, smiles and says "good for you!" knowing inside he got the best deal even though his closing costs were $2,000 higher because of the point he has paid.

Why is this? Because each month of the ten years, Harry is paying $31 less on his mortgage than Joe is. After 10 years, or 120 payments Harry has paid a total of $1,840 less for his total mortgage than Joe has. He got back his $2,000 plus almost another $2,000! This is why Harry just nods and smiles.

The bank is smiling at Joe too! They have collected $1,840 more from Joe and he is the borrower that ends up in the half that has paid too much.

As far as the bank is concerned, Joe has paid in extra to give to Harry and since there are many more of these borrowers that refuse to pay points than there are borrowers who will take advantage of a deal, the bank will not even worry about Harry paying less. There are plenty of Joe's around to take care of Harry and still leave lot's of extra money for the bank.

Here are the numbers for you

Borrower	Joe Borrower	Harry Borrower
Interest Rate	5.5	5.25
Closing Costs	2000	2000
Cost of 1 point paid		2000
Payment	$1,135.58	$1,104.41
Saving per month		$31.17
Savings over 10 years		($3,740,40)

Borrower	Joe Borrower	Harry Borrower
10 years of Payments	136,269.60	132,529.20
Closing Costs	2,000.00	2,000.00
Cost of 1 point paid		2,000.00
Total Price of Loan Package	138,269.60	136,529.20

As you can see, Joe walked away from the closing happy because he paid the lowest costs but ends up paying more for his mortgage than he has to. In fact for every year after 10 years Joe will continue to pay for that happiness at the rate of $374.40 per year.

If both Joe and Harry keep the loan till it is paid off then after 30 years Joe will have paid $11,221.20 more than Harry did on monthly payments.

This is not sounding like such a good idea anymore to save that money at closing, is it?

Even Financing the points can save money
Here is another interesting point to make of why "the lowest costs" are not always the best deal.

If Harry doesn't have the extra $2,000 to pay the points at closing, he can add this to the balance of his loan and borrow $202,000 instead of $200,000. Harry will still save more than $20 per month over what Joe pays every month!

Of course, this is not the same amount of savings as paying a point, but it is still ahead of that borrower who is so dead set on not paying any points, no matter what, at any cost.



Other Financial Considerations.
Before you just jump in and say "wow, paying points is for me!" you really need to look at the other financial considerations that come with this and I strongly suggest that you sit down with your accountant to see if this makes sense.

You might be able to make more money on the the points somewhere other than in your house.

For instance, if you invested $2,000 in retirement fund that averaged an 8% return for 30 years and then forgot about it, that fund would be worth a little over $20,000 after 30 years. Of course, you have to pay tax on the $18,000 profit and this makes the investment worth only a little more than than the points.

There are choices to make and depending on your personal situation there just might be a better way to put that money to use.

Of course, the savings on the mortgage is a guaranteed return and after what we have seen with the ups and downs of the market in the past few years, we all know there is not guarantee in investing that money somewhere else.

Summary
Never pass up the chance to look at the choices you have when it comes to points. The chances are greater that a good mortgage professional can put you into a better situation by using points than if you don't pay them.

Don't be afraid of Points or believe any stories you read about never paying points.

Most importantly, it is your choice, you never have to take a choice when you are getting a loan from a mortgage professional such as myself, but you will certainly be aware of your options and be able to meet the Joe Borrowers of the world and you can be the one who nods and smiles.

---