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Is it worth paying a discount point or origination fee to obtain a lower rate?
The easiest way to answer this question is to calculate the "break even" point. Typically, paying a 1% discount point or origination fee reduces the interest rate by .25% on a fixed rate mortgage. There is a point in time where you break even in terms of recouping the additional dollars spent upfront by saving money on a monthly basis with a lower rate and payment.
example:
30 year fixed rate loan of $300,000 @ 6.0% = $1799/mo. principal & interest
30 year fixed rate loan of $300,000 @ 5.75% = $1751/mo. principal & interest
Paying a 1% discount point or origination fee to lower the rate to 5.75% reduces the monthly payment by $48 per month. However, the cost of the lower rate is $3000. The break even point is: $3000 divided by $48 = 63 months or 5.25 years. It will take over 5 years to recoup the additional money paid to obtain a lower rate.
If a borrower is planning on moving or refinancing in less than 5 years, it would be more cost effective to avoid the discount point or origination fee. If the perspective is longer term, the lower rate may be the best choice.
Things to consider:
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The tax implications are different between a refinance and purchase transaction.
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On a refinance, if the discount point or origination fee is rolled into the new loan, the break even point is longer.
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Paying a discount point or origination on an ARM product may lower the rate more than .25%.
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