Friday, April 6, 2007

point of interest

we are currently securing a loan for a new house purchase. mortgage rates are pretty low these days and some of our lenders are offering to let us buy points to lower them even more. these so called discount points cost 1% of the loan amount and bring down the interest rate 0.125%. so, i started thinking about the merits of buying discount points. it's not nearly as straightforward as i thought, but it feels like a sucker bet to me.

there are a lot of components:

0. your interest rate will change, causing your
1. your monthly payment to change slightly, resulting in
2. your overall cost of the loan changing, and
3. you lose any flexibility that you would have with that money

now, i haven't done any calculations, but the overall savings on 0.125% seems pretty slight to me. that is, i think you could do far better by taking the money and investing it elsewhere.

let's look at a tangible example. let's say you're looking at a $475,000 home, where you need to borrow about $380,000. if you are looking at a 30 year note @ 5.875% where principal and interest comes to $2,250, you'll end up paying $810,000 over the course of the note. if, however, you decide to buy that down, paying 3% of your home cost ($14,000), to 5.25%, you'll end up paying about $2,100 monthly, or $756,000 over 30 years. that comes out to a $54,000 savings. sounds like a lot, huh? well, depending on what you can make on that $14,000, i'd say you'd be better off not buying it down. if you could get about 10% on your money, you're likely to see about 3 triples, or a return around $100,000 on your money!

and anyway you look at it $100,000 > $54,000. so, stay away from the sucker bet, and stash your cash somewhere else.

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