Comparing mortgages confuses many homebuyers. You find a lender offering an interest rate of 10.2 percent, but he's charging four points. Another lender's rate is 10.75 percent with two points. Which is better?
The answer depends on several factors:- How long you're going to stay in the house you buy.
- Whether you have enough cash to pay the points at closing. Each point equals 1 percent of the mortgage (1 point on a $100,000 mortgage would be $1,000), and most lenders will not allow you to wrap the points into the mortgage, except when you are refinancing.
- Whether you can get the seller to pay some or all of the points. If you don't have enough cash to make a down payment and pay several points as well, look for a seller who's willing to take on this expense for you. In slow markets, they're not hard to find.
A good rule of thumb to remember is that each point is roughly equal to one-eighth of a percentage point on the interest rate on a 30-year mortgage. In other words, an interest rate of 10 percent is really 10.25 percent if you have to pay two points.
But most people don't stay in a house for 30 years, so the points turn out to be even more expensive. The less time you keep the mortgage, the more expensive the points are.
Here is a chart some bankers use to show how much points add to your interest costs on a 30-year mortgage.
It's also possible to figure out roughly how much points cost if you plan to stay in a house only a short time. The following formula, worked out by HSH Associates mortgage publishers, is not as precise as the bankers' charts, but it's helpful in making comparisons.
The Andersons are buying a house they plan to keep only five years. They find a 30-year fixed rate mortgage at 10.75 percent and two points at City Mortgage. But at Town Bank, they can get a rate of 10.2 percent if they're willing to pay four points.
Here's how they compared the two.
CITY MORTGAGE TOWN BANK
A. Interest rate 10.75% 10.2
B. Years in home 5 5
C. Multiply line A
by line B 53.75% 51%
D. Mortgage points 2 4
E. Add lines C and D 55.75% 55%
F. Divide line E
by line B 11.15% 11%
Line F is the effective interest rate the Andersons would pay for each mortgage if they stayed in their new house only five years. If the Andersons were to stay in their house 10 yearsTown Bank's mortgage would be more attractive.
You can use this chart to compare mortgages yourself.