Under the Mortgage Microscope: Understanding Points vs. No Points

One of the most common questions that I get as a mortgage broker is, “Can you do a zero point loan?”  
Of course I can, any broker can do a loan with no points. 

The real question is understanding the trade-off between a zero points loan vs a loan where points are paid. (all other things being equal, of course.)

Many “loan shoppers” often focus on this dimension alone and they will run the other way if the lender mentions that a loan has points included.  This is short sighted and illustrates a lack of understanding of where the point costs come from, and what benefit (if any) points may have.  I am not advocating one way or the other for loans, with or without points, the answer to that question needs to be addressed on a case by case basis.   I just want consumers to understand that a zero points loan doesn’t necessarily mean they are getting a low cost loan, and they should evaluate all of their loan costs, both with and without points to determine what is best for them. 

I recognize a borrowers desire to get a low cost loan.  We all want the lowest cost, and best value in anything that we buy.  Whether it be our clothes, a car, a house, or in this case a loan.  It comes down to doing a cost-benefit analysis that will help borrowers understand what they get for the cost of their points. 

Before I explain how to do this analysis, let me be very clear about something.  No matter what kind of loan you get, meaning one with points vs one without points.  The bank is going to make their profit margin on the loan, – end of story.   Pay me now or pay me later, the bank always wins.  With that in mind, the borrower has a decision to make.  Buy down the interest rate with points or take out a loan with no points.

There are 3 ways you can look at this problem.  

If you’re taking out an interest only loan, use this formula. 

  1. Start by finding out what the rate/terms are for a 0 points loan.
  2. Then find out what the rate will be if you pay 1 point.  (make sure the terms don’t change from the original 0 point loan.)
  3. Compare the payments from the 0 point loan to the loan with points, and subtract to find the difference in the 2 payments.
  4. Divide this payment difference into the total cost of the points. 

Here’s an example.  
       $500,000 loan at 0 point, with rate of 6.75% has Int only payment of $2812.
       $500,000 loan at 1 point, with rate of 6.25% has Int only payment of $2604.
       The diference in payment is $208 per month.
       The cost of 1 point is $5,000 which divided by $208 = 24.

24 is the number of months it will take to recouperate the original $5,000 cost of the points.  
Therefore, if you plan to keep this loan for more than 24 months, then you’re better off paying the points and taking advantage of the lower payments.   If you plan to sell or refi within 24 months, then don’t pay the points and take the 0 point loan.

For loans with fully amortizing payments use this formula,

This formula is a little more complicated because you need to consider the difference in principle reduction over a period of time for 2 different interest rates.  Here’s simplified way to do this.  You will need the help of an amortizing calculator which can be found on my website by clicking here – Calculator

  1. Do the calculations shown above for an interest only loan.
  2. Then using the calculator determine the monthly payments for the 2 loans with and without points.
  3. Compare the yearly principle reduction between the 2 loans and find the difference in principle.
  4. The difference in principle along with the difference in monthly payment is added together and divided by the cost of the points to determine a break even point in months. 
    (To get exact numbers I recommend you contact me, because there are other elements to consider in this formula that would be too difficult to explain here.) 

Lastly you should also consider that if you are paying points, you could spend that money on your down payment and therefore reduce the principal balance of the loan.  In this case, I recommend going with the zero points loan if the monthly payment, with the reduced loan amount, is lower than the payment with higher loan balance and points. 

Hopefully, I didn’t lose you in these explanations and you’re still with me.  It’s important that as a consumer you understand how all of this works.  Points can help you lower your rate, knowing whether it makes sense to buy points or not is a matter of doing the math and knowing how long you plan to hold onto the loan. 

As a professional consultant, I calculate the break even point for all of my clients and I let the client decide whether or not they would like a loan with or without points after they have reviewed the analysis.  Sometimes the decision on what loan is best is influenced by other factors, but at least the clients knows exactly where their money is being spent and what the loan is really costing them.


1 Response to “Under the Mortgage Microscope: Understanding Points vs. No Points”

  1. 1 John May 1, 2007 at 12:36 am

    Martin, I like it! I found your link on your AR site. Is this working for you?

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