Now is a great time to refinance your existing mortgage, if you can.  Rates have fallen significantly in the last few months, so if your credit is still good, you’re still employed, not planning on moving soon, and you’re not underwater (have positive home equity), you can save a few bucks.

One question to consider is whether it’s worth it to buy down your mortgage rate.  Points are prepaid interest.  A quick look at a local bank’s rates show that I can get a 15-year-mortgage for a rate of 5.13%, or pay one point and reduce the rate to 4.75%.  One point is 1% of the loan value.  How do I figure out which is better?  Let’s run some numbers.  I’ve put it in a spreadsheet, so you can follow along if you wish.

Let’s assume the loan is for $200,000.  One point is then $2,000.  At a rate of 5.13%, the monthly payment would be $1595.  (In Excel use the @pmt function.  @pmt(rate, periods, loan amount, final loan amount) or @pmt(5.13%/12, 12*15, -200000, 0). )  At a rate of 4.75%, the monthly payment would be $1556, for a savings of $39/month — the difference between the two payments.

Would you pay someone $2000 to give you $39 each month?  This proposal is the same as an annuity.  Wait!  Before eyes glaze over, it’s not that bad.

In your first year, you would save $39*12= $468,  or 23%.  Not a bad rate of return on your $2000 investment.  The actual rate of return over the life of the loan can be found with Excel’s @rate function.  Here:  annual rate = 12*@rate(12*15, 39, -2000) = 22.6%.   However, you’d have to hold the loan for the full term to realize this benefit.  If you refinanced after 5 years, the rate of return on your points falls to 6.4%, still, not too bad.  Roughly, you need to plan to have the loan at least $2000/($39/months)=51 months = 4 years, 3 months, for it to make sense to pay the points up front.

Points are deductible on on Schedule A of your income tax,  prorated over the life of the loan.  See IRS Publication 936 for details.

Tags: mortgage, points, refinancing

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