When does it make sense to pay points on a mortgage?

When it comes to mortgage points, I get confused.  The term “points” has multiple meanings in the mortgage world and each client who asks me about “paying points” has a different definition.
 
Mortgage points can refer to loan origination fees (fees charged by the bank/broker) or discount points (also known as loan discounts). By paying a discount point, you can lower your interest rate. Consider it prepaid interest.

In general, you can knock off about 1/4 to 1/8 of a percent off your interest rate for each point you pay. Because these points are interest payments, they’re usually tax-deductible. A notable exception to that rule, however, is refinanced mortgages. In this case, only a few states allow you to deduct discount points and even then, it’s restricted to certain circumstances. You may also be able to deduct a portion of your points if you refinance your mortgage to raise money for home improvements — regardless of which state you call home.
 
Generally speaking, it takes about five to seven years to recoup the cost of paying a point upfront. Here’s the math. Let’s say you take out a $100,000 30-year fixed mortgage, and you have the option of either paying 6% with no points or 5 3/4% with one point. With the 6% mortgage, your monthly payment will be $600. And with the 5 3/4% loan, it would be $584, a savings of $16 per month. After about 62 months, or a little over five years, you would have recouped the $1,000 point you paid upfront. And then you would start to benefit from the lower monthly payments.
 
But you must also consider how you might otherwise invest that $1,000. If you can beat the taxable equivalent of your mortgage rate (about 8% in the example above for those in the 25% tax bracket) then don’t bother paying points. Invest the money instead.

In fact, over half of my refinances are for “no points and no fees” where the bank pays me a yield spread premium and I can cover the closing costs and still earn a fee.  It’s a win-win and if you think you may qualify try me at 651.210.9593 right now and we can see what your options are.