Should You Pay Points to Buy Down Mortgage Interest Rate?


I am currently refinancing a rental property that I own. The new loan will have a $77,000 principal balance and a 15-year amortization and term. The loan officer presented me with the following interest rate options. Here is how I went about deciding if I should pay points.

3.75% with 0 points

-or-

3.25% with 1.29 points

-or-

3.0% with 2.43 points

To determine if I should pay points, I first need to examine my assumptions. In this case I assume that I will own the property for at least 15 years, during which time I will not refinance this loan (~3 percent is a pretty amazing rate!).

Next, I calculate the actual dollar cost to “buy” each rate:

3.75%: 0 points = no cost

3.25% : 1.29 points = $77,000 x .0129 = $993.30

3.0%: 2.43 points = $77,000 x .0243 = $1,871.10

I then calculate the principal and interest payment for each interest rate:

3.75%: P&I = $559.96 / month

3.25%: P&I = $541.05 / month

3.0%: P&I = $531.75 / month

Finally, I take the total annual savings of each lower interest rate and compare it with the 0 point option to determine a “rate of return” on my initial investment, the dollar cost of the points required to buy down the rate.

3.25%: $18.91 / month savings = $226.92 annual savings

$226.92 annual savings / $993.30 points paid = 23% annualized rate of return

 3.0%: $28.21 / month savings = $338.52 annual savings

 $338.52 annual savings / $1,871.10 points paid = 18% annualized rate of return

To make my decision, I compare the available rates of return on the points paid to my “opportunity cost of capital” or the rate of return I think I could attain on other similar investments. Since buying down an interest rate is a guaranteed (zero risk) investment (unless I were to sell the property), my opportunity cost of capital is very low, say 2-3%.

So I chose to pay 1.29 points for the 3.25% rate because the 23% rate of return exceeds my opportunity cost of capital and is higher than the 18% return offered by the 3.0% rate option.

It should be noted that if I assumed I might own the property for a shorter length of time or refinance in the near future, that would change the decision making process and introduce additional variables into the decision.

If you are still reading this post and thinking to yourself, “Surely there must be a calculator for this type of thing,” you would be correct: rate of return on mortgage points calculator. Now that you understand the decision making process, use the calculator to make your life a little easier and simply compare the results to your own “opportunity cost of capital”.

I hope you found this information useful. For more information about investing in Tulsa real estate or property management in Tulsa, feel free to give the Home Finders office a call today at 918-665-0212.

Regards,

Nate

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