Taking Points

Let’s say you’re a long-time wishful home buyer who’s been watching the housing market carefully, and you’ve decided that prices have finally dropped to where you’re comfortable making a purchase commitment.  Maybe you believe that prices could - even will - drop further, but you’re worried that interest rates trending upward could wipe out any additional savings you might get by waiting longer.  One day, you drop in on an open house in the area you’ve been scouting, and suddenly … you know!  It welcomes you; it just looks and feels right, and the price fits your budget.  You’re ready to take the plunge and buy a home.

The next thing you know, you’re shopping for a loan.  Of the many decisions you’ll be making, one of the toughest is whether or not to buy “points” to reduce the loan’s interest rate.  Everyone who’s been through the homebuying process, and many who haven’t but do their homework, know that a “point” is financial lingo for one percent of your loan amount.  When you shop for a loan, you’re usually offered the option of getting a reduced interest rate in return for paying points or some fraction of a point upfront (though even that cost is often rolled into the loan these days).  A .5 (one-half) percent interest rate reduction might cost you $2,000, for example, but could save you many thousands of dollars in interest over the life of the loan. 

The hard part is knowing how to decide if the tradeoff is worth it.  One good way is to calculate and compare the cost of each option using specially designed online calculators like this one at The Mortgage Professor, a well-respected web site offering a wealth of knowledge and tools for home buyers. 

But Jonathan, an unfailingly curious and resourceful young man who generously shares an endless supply of financial tips and secrets on his web site, MyMoneyBlog.com, has come up with a much easier rule of thumb.  He’s discovered, by trying different combinations of rate/point options and plugging them into the calculators, that there’s a universal break-even point:  if you keep your loan (that is, your house) for about five years or longer, buying points usually pays off.  If you own the house for less than five years, it’s not worth it.  Of course, you should still plug your options in to the financial calculators to find the best one before making a decision.  Jonathan (he seems not to disclose his last name for reasons of privacy and security) has more to say on the subject on his blog.  It is well worth reading on a regular basis for the variety and scope of advice he offers, on subjects as wide-ranging as cell phone plans and grocery coupons to investments and mortgages.