Should I pay points to refinance?

Mortgage rates are at very attractive rates – yes rates have been as low as 4.5 percent in recent years but, relatively speaking, we are at historic lows. (Anyone who owned a house in the 80’s remembers well the days of double-digit interest rates, making today’s 5-6 percent rates look like peanuts.)

If you are buying a new home, or your mortgage rate is adjustable, interest only, or higher than 6.5 percent you should consider locking in a fixed rate. It is likely in the next few years that interest rates will begin to rise, taking mortgage rates with them.

Banks quote mortgage rates in conjunction with points paid, a point being 1 percent of the mortgage. The lower the rate, the more points you pay. It may seem like a “no-brainer” to take the zero point rate, but it often works out to the homeowner’s advantage to pay points. Let’s look at an example:

Bob wants to refinance a $100,000 mortgage. The local bank is offering a 30-year fixed rate mortgage at 5.75 percent with no points (Offer A). They are also offering 5.375 percent with 1.25 points (Offer B). The payment on offer A would be $583.58 per month, and on Offer B would be $559.57. If Bob chooses Offer B he will pay $1,250 in points (1.25 percent of $100,000) but will save $24.01 on his monthly payment. In 52 months, about 4.5 years, he will have broken even on the points he paid.

In general if you are planning to stay in the house for 5-7 years it makes sense to pay points and take the lower rate.