Refinancing costs money, you probably know that. But how much should it cost? Should you pay points every time you refinance? What do the points do?
We help you discover the answers below.
First, let’s look at the definition of points. Lenders may call them discount points or origination points. In reality, discount points help you secure a lower interest rate. Lenders charge a point or two (a percentage of two of your loan amount) in order to give you a lower interest rate. It’s like paying the interest up front in the hopes of securing a lower interest rate.
Origination points are just another term for closing costs. Lenders sometimes lump all closing costs into one origination fee. Others charge the origination fee in addition to the closing costs. No matter how the lender charges the fees, though, know that you’ll still pay third-party closing costs, such as appraisal fees, attorney fees, and title fees even if you pay origination fees.
Should you Pay Discount Points?
Now we’ll look at the points separately. Let’s focus on discount points. Should you pay for a lower interest rate? It depends. What’s your situation? Will you be in the home for a long time? If so, paying the discount points may make sense. You’ll pay to lower your interest rate, but if you’ll be in the home for the duration of the loan’s term, chances are that you’ll make out on the deal.
One way to figure it out is to determine how much you’d save in interest over the life of the loan. Let’s say you can save 0.5% on the rate. Figure out the monthly payment for both the higher rate and the 0.5% lower interest rate. Next, calculate the savings over the life of the loan. Do the savings exceed the amount you’ll pay in discount points? If the number is high, it’s a no brainer. If you’ll only save a little more than the discount points will cost, though, it may not make sense to pay the points.
Should you Pay Origination Points?
Next, we’ll look at origination points. This has nothing to do with your interest rate. Lenders choose to charge origination points when your loan is either risky or requires more extensive work than the standard loan.
Should you pay the points? It depends on your circumstances. Has it been hard for you to find a lender willing to give you a loan? If so, paying the points may be your only way to get the loan. If you can have your pick of lenders, though, paying points may be unnecessary.
Stop and think about why you want to refinance. Are you trying to save money, get out of an adjustable rate loan, or change your term? Is refinancing imperative or are you just doing it because rates fell and everyone else is doing it?
The answers to these questions will help you determine the right choice. If you are trying to save money, paying points upfront may not be the answer. If you need to get out of an adjustable rate loan or risky term, you may not have a choice.
Either way, figure out your break-even point. This is the point that you pay off your closing costs and start realizing the savings of the new loan. The break-even point compares the total closing costs to the monthly savings:
Total closing costs/Monthly savings = Months to break-even
Use the break-even point to help you decide if paying points make sense. If your break-even point is something crazy, like 6 years or more, it doesn’t make sense to pay the excessive closing costs. If, on the other hand, your break-even point is short and you know you’ll be in the home much longer than the break-even point, paying the points may make sense.
Deciding whether you should pay points when you refinance is a personal decision. Think about the reason you’ll pay them. Do you really have to refinance or are you just doing it because everyone else is? What do you stand to gain from the refinance? Will paying points help you financially or will it cost you more in the end? Asking yourself these questions and evaluating your position will help you decide what is right.