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When home-loan shopping, don’t be afraid to pay points

“What’s your rate?” “What’s your rate?” This is the major question most home borrowers seem to ask when shopping for a loan.

I don’t blame you one bit for asking, but that’s like asking doctors for a diagnosis without even showing up to see them.

Honest, knowledgeable mortgage loan officers cannot truthfully answer that question without taking full, accurate loan application information and studying all three mortgage credit reports. We don’t know what rates and programs you qualify for without that information.

There are thousands of loan programs. The credit reports and scores you get online do not have the data we need. And scores are far from everything we need to know, even if your scores are 750-plus.

But what about points? People focus on loan rates and don’t ever learn that points can do a lot for them. They are not a bad thing, and they’re part of how rates work. And they are a fantastic financial tool.

Once you understand what points are, you’ll probably like them. The majority of my loan clients like them and use them, because they understand them and are willing to listen. Some folks just tune out — their huge loss.

Would you invest $1,000 today with a guarantee that your money would double in four years? What if it would double in five or six years? If you were totally convinced that your money would double in five years, wouldn’t you invest everything you could?

Well, that’s how points work, as long as you leave the loan in place four, five, or six years or more.

Say your loan amount is $200,000. Because of how rates work, let’s say paying one point — 1 percent of the loan amount — would lower your mortgage payment by $100 a month. That is, you invest $2,000 to lower your payment by $100 a month. How long before you make your money back?

Answer: You make your $2,000 back in 20 months, right? Easy.

Now the fun question: If you keep that loan for five years, how much did you save? The simple math answer is you’ll save $4,000 over the next 40 months after you break even.

What? You invested $2,000 and were paid back $6,000 in just five years? Totally guaranteed? Yes, that is how home loan points work.

A 20-month break-even on a loan kept for five years has a guaranteed annual compounded cash-on-cash return on investment of more than 20 percent per year. Do you know of any other investment with guaranteed rates of return like that, year after year?

Most of my clients break even from 18 to 30 months on any points they decide to invest in their home loan. A 30-month break-even is still a 15 percent guaranteed compounded annual return on the investment for five years.

Isn’t it amazing that loan points — something you’ve always thought were terrible, something to avoid at all costs — turn out to be just about the best deal in the world?

I can hear you now: “Gee, Dave, what would happen if I invested 10 points?” That is, 10 percent of the loan amount. Whoa there, hold on.

A loan officer could easily put you in the wrong loan program and tell you that’s all you qualify for. If you qualify for a program with a 6.25 percent fixed rate for 30 years and you are told you qualify for a loan program with an 8 percent fixed rate for 30 years, you’ve been hurt no matter how many points you pay.

So it’s essential that you first shop around to find the best rate you can get before you start considering points. Once you’re in that position, should you indeed invest five or more points in your loan?

It’s unlikely that you should pay that many points, but every person’s situation is different. The answer is largely based on how long you’d leave the loan in place. The longer you’ll keep the loan and the property, the more points it could make sense to invest — up to a limit, which is different for each loan program and borrower.

Dave Peters is a semiretired loan officer and credit repair specialist. He is a trustee of the nonprofit organization Credit Learning Systems, which teaches college students about credit and debt. He’s author of the book “How Credit REALLY Works” and is a guest on radio shows nationwide. E-mail him at creditmatters@atpco.com.