A while back I wrote an article about paying points to refinance and why, even though we tend to hate the idea of upfront costs, it can be a huge benefit in the long run. In that article I said that you’d benefit from paying points upfront “when the cost of the buy-down pays for itself before you refinance again.” That’s good advice, but a lot more people will actually benefit from paying points up front, so here’s a slightly more advanced take on the subject.
To make things simple, I’ll use the mortgage rates and loan amount from the post about paying points to refinance. In that particular situation, paying $9,600 in points upfront on a $600,000 loan would save the borrower $300 a month on his or her monthly payment. As a result, the buy-down cost of $9,600 would pay for itself in a little less than 6 years; so, the cost would be worth it if the homeowner expected to remain in the home for more than 6 years. That’s just one side of the story, there’s another side that most people don’t think about.
Put the Savings Toward the Loan
Ok, so if you don’t pay the points, you’re payment is $300/month more than it will be if you do pay the points, so, if it’s up in the air and you can afford to make the higher payment, you should factor in one more thing. Since you were considering the higher payment anyway, what if you were to pay the points and put the $300 savings toward an extra principal payment each month? Well, at the end of the 6 years, the roughly $20k cost will be returned, but what if you then decide to stay in the home until the loan is paid off? At the end of 30 years, you’ll have saved $135,911 in interest payments and you’ll pay off your home 8 months faster!
In Layman’s Terms
So basically, it boils down to this: In this particular situation, if you’re going to stay in the home for at least 6 years, it will benefit you to buy down the rate, but every month you stay in the home past 6 years, you’re going to see extra savings that you wouldn’t have seen had you not paid points for the lower rate.
The Investment Approach
The other option is to pay the points, buy down the rate, save $300 a month and, instead of putting that money back into the loan, you invest the savings. At a measly 4% return, $300 a month will turn into $24,746 after 6 years, $44,619 after 10 years, and a whopping $209,188 after 30 years. You shouldn’t have any problem finding an investment that will pay a 4%.
Now, more realistic returns on, say, the stock market would be around 8-12% – let’s call it 10% for the sake of the demonstration. Investing $300 a month for 6 years at 10% would give you $29,965, after 10 years you’re looking at $62,232, and after 30 years that little ‘ole $300 a month turns into $683,381!
Obviously the investment approach yields the greater benefit and, in fact, the roughly $20k cost of the loan we covered earlier would pay for itself a bit sooner than 6 years using this approach.
It’s All in the Numbers
In California, a $600,000 loan is quite common; ultimately, how the numbers work out will completely depend on your situation and these calculations need to be made by you, your financial advisor, or your mortgage advisor. Whoever does the math, it needs to be done, we’re talking about a lot of money here. So quit sitting on your butt and get to it!