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Why “No Points” 30-Year Fixed Loans Don’t Make Sense
By: Carey Pott
I hear it all the time, and you probably do too. On the radio, TV, in the
newspaper or online – “Call now to get a 30-year fixed loan at x% with no points
or fees!”. I’d like to explain to you why this almost never makes sense.
First, we need to make an assumption – if you’re getting a 30-year fixed loan,
you’re planning on keeping the loan for several years. This may seem simple, but
so many people get 30-year fixed loans because it’s what they’ve always gotten
or because everything else is perceived as risky. If you’re not going to keep
your loan for at least 7-10 years, it makes no sense to get a 30-year fixed
loan. There are products available called hybrid ARMs (adjustable rate
mortgages), which allow you to fix your rate for a set period of years
(typically 3, 5, or 7 years). These loans usually have lower rates than 30-year
fixed loans. If you’re not going to keep the loan for over 5 or 7 years, you
shouldn’t pay more to keep it fixed longer than that.
So, you’ve decided that unlike the majority of people who refinance or sell
their home every 3-5 years, you’re going to stay in your home and do not plan to
refinance for at least 7-10 years. In this case, it may make sense for you to
get a 30-year fixed loan. However, it still doesn’t make sense for you to get a
30-year fixed with no points. In order for you to understand why, I have to
explain how loans and interest rates work.
When you go to a lender to get a 30-year fixed loan, they will tell you what
interest rate you qualify for. If your loan officer is good, they will explain
to you that you can buy down the interest rate by paying 1 or more “points”
through the loan (a “point” is simply a lending term that means 1% of the loan
amount, so if you have a $300,000 loan then 1 point is $3,000). If your loan
officer is REALLY good, he’ll explain why it probably doesn’t make sense to get
a 30-year fixed loan without paying any points.
In order for you to see what I’m talking about, let’s assume you’ve got a
$300,000 loan amount and you can get a rate of 6.25%. Your monthly payment would
be $1,847. However, if you agree to pay one point ($3,000) through the loan your
rate will be 6%, which would translate into a monthly payment of $1,798. At this
point, it’s useful to do a “break-even” analysis.
Take the amount you pay in points ($3,000) and divide that by the monthly
savings ($1,847 – $1,798 = $49), which gives you 61. This is the number of
months in which your monthly savings ($49) pay for your point ($3,000). In this
case, if you’re planning on keeping the loan for 7-10 years at least then it
makes sense to pay the point for the lower rate since you’ll be saving money. In
fact you will save $2,900 after 10 years, $8,800 after 20 years, and almost
$15,000 over the life of the loan!
Generally speaking, by paying at least 1 point when you get a 30-year fixed loan
you’ll find a break-even point of 4-5 years. Since we’ve already made the case
that you shouldn’t get a 30-year fixed loan if you’re planning on keeping your
mortgage for less than 7-10 years, and the break-even point is generally 4-5
years, it usually doesn’t make sense to get a 30-year fixed loan with no points.
If you’re in a situation where you’re considering getting a 30-year fixed loan,
I would suggest you do this analysis yourself. Ask your trusted loan officer for
a rate quote at 0 points, 1 points, and 2 points, along with what the payment
would look like at each rate. Then divide the amount you’re paying in points by
the monthly savings to find your break-even point. If that break-even point is
at least a year less than the amount of time you’re planning on keeping the
loan, then pay the money and save in the long run!
About the Author:
Carey Pott is an experienced mortgage broker. You can find more information on
mortgage financing at http://www.januaryfinancial.com. Carey is also a frequent
contributor to many websites with mortgage articles, including http://www.homeexpertsonline.com.
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