Refinancing a mortgage - points or no points?

OK – technically this isn’t a post about screwing up a business, but it is worthwhile information anyway.


I just had a question from a client about refinancing a mortgage. He had three choices:

1. Stick with his current high rate mortgage
2. Refinance to a lower rate with no points
3. Refinance to a still lower rate with points

This is the analysis I sent him:

Paying a lower interest rate with no closing costs is always better than sticking with a higher rate from an economic standpoint - even if you are paying an extra $100 per month against principal now.

The real question is whether paying the closing costs to get the lowest rate is worthwhile. To do that all you have to do is take the difference in monthly payments between the two loans and divide that into the closing costs. That tells you how many months it takes the lower rate (with closing costs) to catch up to the rate with no closing costs. Here is an example with made up numbers:

Closing costs: $3,000 to pick a wild number
Monthly payment under lower rate with closing costs: $850
Monthly payment under slightly higher rate without closing costs: $950

The difference in monthly payment is $100 per month. If you take the $3,000 closing costs and divide by $100 payment difference, you get 30. That means in 30 months, you begin to save money with the loan with the closing costs. If you plan on keeping the house beyond 30 months, paying the closing costs makes sense in this example. If you aren't going to have the house in this example for at least 30 months, the loan without closing costs makes more sense.