In my former life...back in the day...before kids...almost 20 years ago, to be exact...I worked as a mortgage loan processor for a savings and loan association. Do S&L's even exist anymore? I don't think there are any around these parts, at any rate. Maybe they all vanished in the great Crisis. I know the one I worked for got bought up by another S&L, which was bought up by a bank, and who knows what it is now. Wait...this is all starting to sound familiar.
Anyway, way back then, we refinanced a lot of mortgages when the rates were plummeting during the heyday of the Reagan Revolution. When a customer wanted to refinance we tried to help them figure out which combination of rates and points saved them the most interest over the period of time they were likely to own the house. There was a calculation we used to figure a break-even point where it made more sense to go with a higher rate versus paying more points.
As I recall, the way it worked was like this: Customer needs to refi $200K loan. Interest rate X will yield a monthly payment of $1,000 and customer will pay 1 point. Interest rate Y will yield a payment of $1,100 and Customer will pay no points. Since one point would be $2,000 and the difference between the payments is $100/month, the break even point is 20 months. So, if Customer plans to keep the house for longer than 20 months he will save money by going for the lower rate.
So, this makes perfect sense to me if Customer is paying that point in cash at closing. (Although maybe we should take the equation further and estimate how much interest he's losing by not investing the money instead. But we'll assume he banks at Wachovia and gets .05% on his savings account, so it's sort of a non-issue.)
What I can't remember is this: Does this break-even calculation work if Customer is financing the points into the refinanced loan? The points are, in effect, getting spread out over the life of the loan and thereby making the payment higher. But the lower interest rate is also making the payment lower...and that's where my brain got all creaky and started yelling at kids to get off its lawn.
Anybody got an answer for me on this? Any wild guesses? Anyone? Anyone? Bueller??