By Jeff Brown

With interest rates at extraordinary lows, this is a great time to take out a new mortgage, either to buy a new home or to refinance an existing loan.  The standard 30-year fixed rate loan averages just 5 percent, according to the BankingMyWay.com survey.

With interest rates at extraordinary lows, this is a great time to take out a new mortgage, either to buy a new home or to refinance an existing loan. The standard 30-year fixed rate loan averages just 5 percent, according to the BankingMyWay.com survey.

As soon as you start shopping around, you are confronted with a dilemma: should you pay "points?" There is no easy answer to that question -- sometimes yes, sometimes no.

Points are up-front interest charges, with each point equaling one percentage point of the loan amount. If you borrow $200,000 with one point, you’d have to come up with an additional $2,000 to complete the deal at closing. The points go directly to the lender.
Obviously, no one likes paying points, and if you were choosing between two mortgages with the same interest rate, you’d want the one charging fewer points. Many mortgages charge none.

But the choice is usually trickier. Generally, paying points gets you a loan with a lower interest rate, giving you a lower monthly payment. You have to do a little math to see how long it will take the lower payment to offset the cost of the points.
The BankingMyWay.com mortgage search tool recently showed a 30-year fixed-rate offer from Quicken Loans with zero points and a 5.25 percent rate. Another lender, the Pentagon Federal Credit Union (Penfed), offered a 4.5 percent rate for borrowers willing to pay 2.25 points.

The mortgage-payment calculator shows monthly payments of $1,104 for the Quicken loan and $1,013 for the Penfed offer – $91 less.
If you borrowed $200,000, the Penfed loan would charge $4,500 in points. By dividing $4,500 by $91, you see that it would take nearly 50 months, or just over four years, for the monthly saving on the Penfed loan to equal the payments in points. 

In other words, if you have the mortgage for longer than 50 months, paying points pays off. After that period ends, your mortgage will continue to cost $91 a month less than if you had taken the zero-points loan. You’d save just over $28,000 in the remaining 310 months of the 30-year mortgage.

In examining the breakeven point, most people focus on how long they will live in the house. Keep in mind, though, that you could stay in the home but retire the mortgage with another refinancing, or by coming up with cash to pay the loan off early. Regardless of the reason, if you get rid of the mortgage before the breakeven period ends, you lose money by paying points.
Other factors may influence the decision, such as whether you have the cash to pay points.

Also, some homeowners add another layer to the calculations by looking at potential investment returns. By paying $4,500 in points in the example above, you could save $91 a month by reducing your payments -- $1,092 a year, a generous payback. On the other hand, you might have a more pressing need for that cash, such as a home improvement or college tuition bill. And in other cases, paying points might not provide such a dramatic monthly savings, and an alternative “investment” might be more promising.

Some homeowners can deduct the cost of points on their federal income tax returns, either in the year they are paid or spread over a number of years. It’s a complicated topic, but generally, taxes should take a backseat to questions of whether you can afford the points, and whether you will keep the mortgage long enough to make paying them profitable.

— For more ways to save, spend, invest and borrow, visit MainStreet.com.