So we're gonna walk through a misconception that a lot of people have and the mistake that so many people make all the time when it comes to points.
So really quickly, as you might be able to tell. My goal is to help you make smarter mortgage decisions. So that you can build wealth with real estate faster.
So paying points. Let's talk about one, what it is? If you're unfamiliar with it. Paying points is essentially where we take the part interest rate. We prepay interest so that we can drop the interest rate now over the short term. We end up paying more money until we get to a breakeven point over the long term. Paying points has the potential to save us a lot of money, but I wanna show you where most people get their math wrong.
So let's walk through this demo. I'm a big fan of demos if you can't tell. So this is with a $300,000 purchase price. Yours might be more or less. But we're saying that the annual interest rate is 4.75% on a 30-year loan. Now, if we paid points, we're acting like the scenario is we're paying three points or $9,000 to receive an interest rate of 4%. So the emotional decision is immediately 4% sounds a lot better than 4.75%.
This is what people do. So the annual rate is 4.75%, the loan amount is $300,000, the term is 30 years with zero points. So if we took the loan as is, at 4.75%, our payment is $1,565. Not too bad. If we paid points. So we paid $9,000, we would bring the interest rate to 4%. Our payment comes to $1,432, and this is where people mess up.
So we save $133 per month, and this is what everyone does. If you can see my calculator up here, it'll take $9,000 and divide it by 133 and they get this number 68. So they say, okay, great. As long as we're in the house, for more than 68 months, we'll break even. Then, we start to make money. Which is half true.
So everyone's making that decision and saying, yeah, we'll be in the house more than five years. So this is almost, this is five years, eight months, and at five years and eight months is the point where you break even just breaking even then we start making money after that.
So this is how most people think, but it's a little incorrect and I'll show you why. Because we're not considering it a fair apples-to-apples comparison. In this scenario, we invested nine grand into prepaid interest, but we're comparing that against investing, not even investing nine grand at all.
So what we have to do is we have to compare investing nine and into the rate or nine grand to reduce the loan amount. So you see what we're comparing here now? Reduced interest rate versus reduced loan amount. This is the real conversation that we need to have. Because what we see happens is we're taking a higher interest rate here, but we're taking a lower loan amount, the same term. We can see that there's still a payment deficit over here, it actually costs us $86 more per month than the points option.
But what's happening is we still have equity in the property because ignoring this number for a second is just paying points. If we paid points, you close a loan the day after you close the loan, you're out nine grand, right? You paid nine grand into the interest of the property.
If you want it to sell that property, let's say in two years you're out a couple of grand. Actually more than a couple you're probably out seven, eight grand. If you took a lower loan amount, day one after closing, you have $9,000 positive equity on top of the down payment, because that money got paid into the loan amount. So if you're tracking with me here, that's more money that can take appreciation in the future.
So the real-time it takes to recover points is not five years and eight months. It's actually 105 months. You're talking 8.75 years, not five years, 8.75 years to break even on points. Because what we're saying here is that it takes five years and eight months to breakeven for us to gain the same equity position in the lower mortgage is going to take an additional three to four years to go to the same equity position, right? Because we're looking at the future value of money. If we put money into an expense, for example, paying down the interest, that's not money that we get back immediately. It shifts our payment structure, but we don't get it back in equity.
Whereas if we reduce the loan term, that is equity that we have access to immediately when we sell the property. so I hope this clears up this points myth. Points can still be a fantastic option. We can see here that once we get to 8.75 years, then we start seeing an actual real return on our money.
So if you are looking at points, I want you to consider that structure is not just taking the number of points divided by how much we save. That's not a fair comparison using the future value of your money. Compare it against if you took down a smaller loan, what that would look like over time.
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