Whether buying property or refinancing, you have the option to pay for points and lower the mortgage interest rate.
What are the pluses and minuses of investing in points? And what analysis must you make to decide if buydown points are in your best interest? I’ve got some answers for you today.
What exactly are points?
Points, sometimes called discount points, are nothing more than interest paid in advance to achieve a lower interest rate.
Think of a teeter-totter. The more you push down on the interest rate, the higher the points (cost) to accomplish that lower interest rate.
Points are calculated based on the loan amount, not the sales price or property value. For example, the purchase price is $1 million, and the loan amount is $800,000. One point of the $800,000 loan amount is $8,000.
Each point will knock your interest rate down by 0.25% to as much as 0.5% (depending on the lender and the specific base rate). You can also pay fractions of a point for a smaller buydown. For example, one-half point will reduce your rate by roughly 0.125% to 0.25%.
Behind the mortgage curtain
Confusing as it is, loan origination points might also be in play.
Origination points have nothing to do with your rate buydown points. These points are the compensation paid to a mortgage loan originator or MLO.
For example, let’s say that the $800,000 loan amount on a 5.625% interest rate, 30-year fixed costs the MLO nothing or zero points. Industry parlance calls this “par pricing.” The MLO or the lender might mark this up by 1 loan origination point ($8,000) to cover MLO compensation.
Let’s say you are paying 2 points — 1 point for the loan origination compensation and 1 point for the mortgage interest rate buydown. Your 2 points get you to 5.25% instead of the 5.625% you would have paid with just 1 point.
Generally, you can pay a maximum of 3 points under the Truth in Lending Act or TILA. This includes both origination points and buydown points.
You must ask your MLO to break down the points — if the points are origination points or buydown points or both. Points are typically not broken down as to what are buydown points versus loan origination points on your loan estimate.
For example, let’s say the MLO charged 2 origination points and no buydown points. That essentially means the MLO is charging you $16,000, not $8,000 in compensation. You can use this information to negotiate lower MLO compensation, so more money is being used to pay the buydown cost (or you can shop elsewhere).
Why buy points?
The pluses of paying points are you receive a lower interest rate and a lower house payment.
The points are completely tax-deductible in the year the points were paid in respect to a purchase. For refinancing, you must amortize the point(s) over the life of the refinance. For example, on a 30-year mortgage you would deduct 1/30th of the points each year.
Most mortgages are only kept for 10 years. So, you would be able to deduct the remainder of the points once that refinance loan is paid off.
If rates stay the same or go higher over time, and you stay at home for a long time, then a rate buydown can be a good move. We just don’t know for certain where rates are headed … that’s crystal ball stuff.
The minuses of paying points are you are putting forth money or chopping away at your equity in the case of a refinance.
If you don’t keep the loan for a long period of time due to a sale or refinance, then the points were not well spent.
Questions for yourself
Do you need the point funds for something very important that you cannot otherwise come up with? For example, you need to buy furniture for your new home and it’s cheaper to pay cash than to put the goods on a credit card.
How long do you think you are going to live in that home before you sell it? Obviously, if you are not going to stay long, don’t pay to buy the rate down.
Do you think interest rates are going to come down (crystal ball thinking again) in the near term? If you do think rates are going to come down, then save your buydown money as you’ll get cheaper pricing soon enough.
My rule of thumb is if you can recoup your costs in 36 months or less, then it can make sense to pay points.
For example, the $800,000 mortgage at 5.625% has a 30-year amortized payment of $4,605. Excluding the tax benefits, the same mortgage bought down to 5.25% has a $4,418 payment. The difference is $187 per month. So, $8,000 in cost divided by $187 (payment difference) takes almost 43 months to break even. So, in this case it doesn’t make sense to buy the rate down.
If you can get the home seller to pay for the rate buydown points, then jump on it.
Something else
Right now, my crystal ball sees lower interest rates ahead, which means you might find it cost effective to refinance. The economy is showing more signs of a slowdown even though inflation is still running hot.
Also, President Donald Trump is going to replace Fed Chairman Jerome Powell with someone more sympathetic to lower interest rates. Mortgage rates are indirectly affected by Fed short-term rate cuts. So, paying points now may not be optimal as rates may go lower.
Freddie Mac rate news
The 30-year fixed rate averaged 6.19%, 4 basis points lower than last week. The 15-year fixed rate averaged 5.44%, 7 basis pointslower than last week.
The Mortgage Bankers Association reported a 1.4% mortgage application decrease compared with one week ago.
Bottom line: Assuming a borrower gets an average 30-year fixed rate on a conforming $832,750 loan, last year’s payment was $273 more than this week’s payment of $5,095.
What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.375%, a 15-year conventional at 5.125%, a 30-year conventional at 5.75%, a 15-year conventional high balance at 5.625% ($832,751 to $1,249,125 in LA and OC and $832,751 to $1,104,000 in San Diego), a 30-year-high balance conventional at 6.125% and a jumbo 30-year fixed at 6.125%.
Eye-catcher loan program of the week: A 30-year mortgage, fixed for the first five years at 5.375% with 30% down payment and 1 point cost.
Jeff Lazerson, president of Mortgage Grader, can be reached at 949-322-8640 or jlazerson@mortgagegrader.com.