“Buydown points” is that a good idea for me on my new loan?

When a buyer takes out a loan on a property, the lender will often times ask for the borrower to pay a “point”. The money goes to the lender to increase the yield on the loan. One point is defined as one percent of the loan amount……not one percent of the purchase price. A $100,000 sale price with a $20,000 down payment would leave a loan amount of $80,000. If the lender asked for one point, the amount would be $800.

Sometimes you will hear loan rates quoted as X% with a 2% loan origination fee. For purposes of this discussion, points and loan origination fee are the same thing.

How are points useful? Let us say you have been pre-approved for a 6% loan in the amount of $200,000. That would require a payment of $1,200 per month. Remember it is the monthly payment amount that the bank uses to qualify a borrower. If the borrower has the cash to pay a point (or sometimes we can get a seller to pay it), then that payment “buys down” the interest rate to a lower level. With a lower rate, the payment comes down and it will allow the borrower to be able to borrow more money. Using our example above, let’s say we pay one point. The rate would drop to 5.75% (but the payment amount would not change) which would allow a borrower to get a loan for $210,000. If 2 points were paid that would increase the loan amount to $217,500 while keeping the same monthly payment. That extra purchasing power could be very useful in buying just the right property.

I always say that “Whether you should pay points is a math problem.” Again, using our example from above, if one point is paid, that would amount to $2,000. The decrease in payment (from $1,200 to $1,100) is a savings of $100 per month. Hence it would take 20 months for you to get your $2,000 back. If you feel that you will own the house for at least the 20 months, then you should seriously consider the option of paying points.

By these examples you can see there are 2 reasons to pay points: (1) to allow you to qualify for a larger loan; or (2) to lower the monthly payment.