When you’re considering a mortgage with lender credits or discount points, it helps to determine how long it will take to break even. Simply stated, you break even when the savings from one of these loan features even out with its cost. You can ask your lender to share this information with you. But it’s also pretty easy to find a mortgage calculator online and run the numbers yourself, particularly for fixed-rate loans. Here’s a primer for determining when you’ll break-even on points that change your closing costs.
Lenders have plenty of incentives to earn your business. Many offer credits, sometimes called origination points, that reduce or eliminate your closing costs in exchange for a higher interest rate. For a buyer already struggling to come up with a down payment, a lender credit can prove invaluable. And the lender earns more in the long run.
So when do the benefits for each party even out? Just divide the value of the lender’s credit by the difference in your monthly principal and interest (P&I) payments at the higher and lower interest rates. For example, on a $180,000 loan, the lender could offer a $675 credit toward closing costs by bumping your interest rate from 5% to 5.125%. The rate change would increase your monthly P&I by about $14. Under this scenario, it would take about 48 months ($675 ÷ $14 = 48.2) for the difference in P&I to offset the value of the credit. If you sell or refinance before then, the credit will have saved you money—unless the loan comes with a prepayment penalty, which lenders disclose on the Loan Estimate.
By reducing monthly payments in exchange for an upfront fee, discount points are pretty much the opposite of lender credits. And if you have the funds, they are a great way to save in the long run.
So, how long does it take before discount points begin to yield savings? Just divide the cost of the points by the difference between your monthly P&I payments at the higher and lower rates. For example, if you qualified for a $400,000 fixed-rate loan with 5.25% interest, a $4,000 point could reduce your interest rate to 5%. This, in turn, would shave $61.52 off your monthly payment. Under this scenario, it would take nearly 65 months (5 years, 5 months) for savings to kick in ($4,000 ÷ $61.52 = 64.9). If you sell or refinance before then, the discount point will have cost you money. Of course, you also would have received a larger tax break in the year you closed, because discount points, like mortgage interest, are tax-deductible.