It seems like it is common practice to calculate a "break-even period" for mortgage points by: (1) taking the monthly savings on the mortgage payment that you get by buying points, and (2) calculating how many months it would take for that savings to offset the up-front cost of the points.
Take this NerdWallet calculator for example. I plugged in the following: Loan amount = $1,000,000; Loan Term = 30 years; Interest rate without points = 6%; Number of points = 1; Interest rate with points = 5.75%. The output is a break-even period is 63 months. It's easy to confirm that this is calculated using the simple method I described above: cost of points = $10,000; monthly savings = $160; $10,000/$160 = 63.
But this seems wrong. For one thing, it doesn't consider the time value of money, but let's put that aside. The main problem is that it doesn't consider the remaining liability at the break-even date.
For example, with the loan terms above and no points (interest rate of 6%), after 63 months you would have a remaining mortgage balance of $926,495. With 1 point (interest rate of 5.75%), on the same date, you would only owe $923,429, over $3,000 less. That's because while your mortgage payment was lower, your principal payment was higher. So if you sell the house and pay off the mortgage at the 63 month mark, your net proceeds will be over $3,000 higher in the with-points scenario, meaning you actually could have "broken even" well before that -- turns out to be at 48 months.
It wouldn't be hard for the calculators to factor this in, so why don't they? People ignore discounting all the time, so it doesn't surprise me that the calculators omit that. But this seems like an obvious, easily quantifiable dollar amount that is just ignored.
Take this NerdWallet calculator for example. I plugged in the following: Loan amount = $1,000,000; Loan Term = 30 years; Interest rate without points = 6%; Number of points = 1; Interest rate with points = 5.75%. The output is a break-even period is 63 months. It's easy to confirm that this is calculated using the simple method I described above: cost of points = $10,000; monthly savings = $160; $10,000/$160 = 63.
But this seems wrong. For one thing, it doesn't consider the time value of money, but let's put that aside. The main problem is that it doesn't consider the remaining liability at the break-even date.
For example, with the loan terms above and no points (interest rate of 6%), after 63 months you would have a remaining mortgage balance of $926,495. With 1 point (interest rate of 5.75%), on the same date, you would only owe $923,429, over $3,000 less. That's because while your mortgage payment was lower, your principal payment was higher. So if you sell the house and pay off the mortgage at the 63 month mark, your net proceeds will be over $3,000 higher in the with-points scenario, meaning you actually could have "broken even" well before that -- turns out to be at 48 months.
It wouldn't be hard for the calculators to factor this in, so why don't they? People ignore discounting all the time, so it doesn't surprise me that the calculators omit that. But this seems like an obvious, easily quantifiable dollar amount that is just ignored.
Statistics: Posted by barnaby444 — Fri Aug 02, 2024 8:34 pm — Replies 1 — Views 292