Mortgage Rate Calculators Turn Mortgage Discount Points Into Dollars You Can Understand

One of the most confusing concepts for mortgage shoppers is the concept of paying discount points on a mortgage. The word "points" refers to percentage points (or more commonly, some fraction of a percentage point) charged at the initiation of a mortgage, theoretically in exchange for a lower interest rate over the life of the mortgage. To figure out if this will really save you money when choosing a refinance mortgage, you'll have to learn something called the refinance calculator two-step.

There's More Than Interest Rates

Unfortunately, people tend to look right past the points and simply compare interest rates. While it is true that, over the course of a 30-year mortgage, the interest rate is likely to have more impact on you than points paid up front, it is also true that a dollar paid today is worth more than a dollar paid at the end of a 30-year mortgage. So, to put points and interest rates on an even playing field, you need to go through two steps using a refinance calculator.

The Refinance Calculator Two-Step

First, some terminology. You may hear the term "basis points" thrown around. In interest rate terms, a basis point is one one-hundredth of a percent, so that a full percentage point is 100 basis points, half a percent is 50 basis points, and so on. The terminology just makes it easier than always referring to fractions. This is especially useful when talking about discount points and interest rate differentials, since these are seldom exactly a full percentage point.

So, let's say you are comparing two refinance mortgages and one offers you the opportunity to save 15 basis points in annual interest in exchange for paying a 50 basis point discount fee. Is this a good deal?

To answer that correctly, it's not enough to figure out that saving 15 basis points a year over the course of a 30-year mortgage will amount to far more than the initial 50 basis point investment. You have to account for the fact that savings in the future have to be discounted in order to be compared to savings today. This is where the refinance calculator two-step comes in.

First, figure out the dollar value of the points you would be paying. Second, add this to the initial principal on the mortgage with the points, while keeping the mortgage without the points at the actual amount you are refinancing. Now see which results in the most total payments--principal and interest--over the life of the mortgage. The result is a good indicator of which would be the more expensive option.

APR, or annual percentage rate, is also a good statistic to look at when comparing mortgages, because it does include points in its calculation. However, APR also includes other variables, so if you are just trying to isolate the trade-off between discount points and interest rates, the refinance calculator two-step is a good technique.

Posted By :
Richard Barrington is a freelance writer and novelist who previously spent over twenty years as an investment industry executive.

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