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Why "No Points" 30-Year Fixed Loans Usually Don't Make Sense

Written by: Carey Pott

I hear it all the time, and you probably do too. On the radio, TV, in the newspaper or online - "Call now to get a 30-year fixed loan at x% with no points or fees!". I'd like to explain to you why this almost never makes sense.

First, we need to make an assumption - if you're getting a 30-year fixed loan, you're planning on keeping the loan for several years. This may seem simple, but so many people get 30-year fixed loans because it's what they've always gotten or because everything else is perceived as risky. If you're not going to keep your loan for at least 7-10 years, it makes no sense to get a 30-year fixed loan. There are products available called hybrid ARMs (adjustable rate mortgages), which allow you to fix your rate for a set period of years (typically 3, 5, or 7 years). These loans usually have lower rates than 30-year fixed loans. If you're not going to keep the loan for over 5 or 7 years, you shouldn't pay more to keep it fixed longer than that.

So, you've decided that unlike the majority of people who refinance or sell their home every 3-5 years, you're going to stay in your home and do not plan to refinance for at least 7-10 years. In this case, it may make sense for you to get a 30-year fixed loan. However, it still doesn't make sense for you to get a 30-year fixed with no points. In order for you to understand why, I have to explain how loans and interest rates work.

When you go to a lender to get a 30-year fixed loan, they will tell you what interest rate you qualify for. If your loan officer is good, they will explain to you that you can buy down the interest rate by paying 1 or more "points" through the loan (a "point" is simply a lending term that means 1% of the loan amount, so if you have a $300,000 loan then 1 point is $3,000). If your loan officer is REALLY good, he'll explain why it probably doesn't make sense to get a 30-year fixed loan without paying any points.

In order for you to see what I'm talking about, let's assume you've got a $300,000 loan amount and you can get a rate of 6.25%. Your monthly payment would be $1,847. However, if you agree to pay one point ($3,000) through the loan your rate will be 6%, which would translate into a monthly payment of $1,798. At this point, it's useful to do a "break-even" analysis.

Take the amount you pay in points ($3,000) and divide that by the monthly savings ($1,847 - $1,798 = $49), which gives you 61. This is the number of months in which your monthly savings ($49) pay for your point ($3,000). In this case, if you're planning on keeping the loan for 7-10 years at least then it makes sense to pay the point for the lower rate since you'll be saving money. In fact you will save $2,900 after 10 years, $8,800 after 20 years, and almost $15,000 over the life of the loan!

Generally speaking, by paying at least 1 point when you get a 30-year fixed loan you'll find a break-even point of 4-5 years. Since we've already made the case that you shouldn't get a 30-year fixed loan if you're planning on keeping your mortgage for less than 7-10 years, and the break-even point is generally 4-5 years, it usually doesn't make sense to get a 30-year fixed loan with no points.

If you're in a situation where you're considering getting a 30-year fixed loan, I would suggest you do this analysis yourself. Ask your trusted loan officer for a rate quote at 0 points, 1 points, and 2 points, along with what the payment would look like at each rate. Then divide the amount you're paying in points by the monthly savings to find your break-even point. If that break-even point is at least a year less than the amount of time you're planning on keeping the loan, then pay the money and save in the long run!

About the author:

Carey Pott is an experienced mortgage broker and owner of January Financial in Foothill Ranch, CA. He has helped hundreds of clients find the best financing for their home purchase or refinance needs. You can find more information on mortgage financing at www.januaryfinancial.com.

Carey is also a frequent contributor to many websites with mortgage articles, including Home Experts Online, www.homeexpertsonline.com.

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