To Points, Or Not To Points - That is the Decision!

Holy-Moly-Mortgage-Foley...We might not have seen rates this high since the 1500s, when William S. questioned existence. To make things worse, current home prices require centuries to save up for a down payment. A more affordable housing market is possible, but not in 2025. So what do you do when faced with the big question: to Points, or Not to Points? That is the question in 2025! The nominal 6 or 7% interest rate is no problem when you can just buy it down. W.W.W.S do? He's known for prose, so maybe we should look to Descartes for the answer.

Paying points might seem like a shortcut to reduce your monthly payments. However, those 0.25% increments can accumulate rapidly. Is there another option? A mortgage issue is never too overwhelming because it's neither purely art nor science. Solutions always exist in the realm of home finance; it just requires a calculator and some pentameter. But before you spend all your money like it's 1599, remember there's a future to consider. You work hard for your money, so let's ensure it doesn't all end up in the lender's bottom line!

Buy-downs and points are good olde fashion strategies borrowers can leverage to create a lower principal and interest payment. With rates increasing over 250% in less than 24 months, lenders, sellers, and even home builders are leveraging tactic to get would-be borrowers into homes via below market rates. Builders have been doing a great job touting 2-1 buydowns as teaser rates to incentivize buying a brand new home over a resale. Lately a client came to us touting a mortgage rate with a 4-handle with all closing costs paid by the builder. No doubt it was a great deal but we will have to wait and see if the strategy will go the distance, meaning that one will keep the loan long enough to have these costs provide ROI. Certainly this is a bargain if its on someone else's dime, but does it always meet the test of time? Let's clear the smoke not blow it!

First Thought - Paying Points (aka Origination/Discount Points)

Buying points means paying an upfront fee to lower your interest rate. One point equals 1% of the loan amount and usually reduces your interest rate by 0.25%. The precise amount can vary based on the program, loan amount, and numerous other factors. For example, if you borrow $300,000, 1 point would cost $3,000. It might seem appealing to keep adding points to reduce the rate all the days to 3%. However, note that the point-to-rate ratio might be consistent for the first 0.5%, but beyond that, the cost of points can rise significantly. There are many reasons for this, but after the steep increase in costs, borrowers typically get the message. It's overrated, and as Shakespeare once wrote, "the cowl does not make the monk." Unthrifty origination fees, why dost thou spend?

Thumbs-Ups to Purchasing Points:

• Lower Monthly Payments: The primary benefit is the reduction of your monthly mortgage payment by decreasing the interest rate.

• Long-Term Savings: Staying in the home for an extended period allows for more interest savings over the loan's duration.

• Tax Deductible: Points might be tax-deductible, it is essentially pre-paid interest. Your return on your investment will vary based on your situation, so consulting a tax expert is advisable.

• Favors Acquisition: Buying points is a buy and hold philosophy so this usually favors purchase money mortgages. Refinancing with points is less enticing because you already own the home. Its less of a financial decision.

  
  

Thumbs-Downs to Purchasing Points:

• Upfront Cost: Its a significant investment. Think, if you are making the minimum down payment, one-point is equal to one percent. That amount could easily equal 30% of your down payment. It also increases your closing costs. If you are low on funds, this is usually the last consideration.

• Points are non-refundable: You heard it, once you pay for it, you are stuck with it. There is no going back to the lender for a pro-rated refund if you decide to part ways with the loan or the home.

• Breakeven Period: Moving or refinancing before recouping the cost of the investment means the juice needs to at least equal the squeeze. If we are in a rate declining environment think about how long you need to keep the loan by months and years to make a capital worth the while. IMHO 1-2 years worth it, 5 or more it's for the bird!

• Loans are biodegradable: Investopedia notes that the typical American remains in the same residence for a little more than 8 years. This reasoning aligns with the average lifespan of a loan, which ranges from 6 to 10 years. There are numerous reasons to relocate or refinance, so consider that the loan you have today may not be thou last.

If you suspect that a low rate might result in a low return on investment, you might want to explore another option. It's straightforward, easy, effective, and best of all, long-term. The solution isn't hidden; it's as simple as considering trading the capital cost of points for a higher down payment. Remember, the larger the loan amount, the larger the principal and interest payments. Most people budget for a home based on a set dollar amount or a percentage of the home price. However, closing costs should always be included in the total out-of-pocket expenses, so it's crucial to consider the overall picture. Some buyers think about increasing the down payment after closing. While this strategy might work if your lender offers a re-cast option, many people end up just paying the bill as it arrives each month. Therefore, before opting for the minimum down payment with the hope of lower payments by paying points, it's wise to crunch the numbers.

Second Thought - Reducing the Principal

Lower the payment by decreasing the principal amount borrowed. MacBeth insinuated that the best way to stop a bad habit is to never start. Consider this: a smaller loan means a smaller payment, less interest, and fewer challenges if times become difficult. Although your capital is tied up like a genie in a bottle until you cash out or sell, it reduces the long and short-term impact of the debt. If you can't make the capital injection work for you on the day of closing, all is not lost. You can add to the principal at any time, and every dollar matters. Explore biweekly payment options and the concept of velocity banking. All prepayments will reduce the interest paid over time since interest is calculated on the remaining loan balance. How sweet & lovely dost thou pay additional principal?

Thumbs Up to Additional Principal:

• Immediate Savings: Lowering the loan balance reduces monthly payment from day one. You will be less enticed to become a serial refinancer because it will take major rate improvements to make it worth your while (& recovery of closing costs).

• Greater Equity: Next, you will start with more equity but also payoff the loan faster. If the housing market goes all Capulet will not have to count on every last dollar of the appraisal. No one ever wants to come to the table on a refinance with a check. If the loan has mortgage insurance, the elimination of this added tax should be a priority.

• Albatross around the Refi: Unless you're sure this is the final loan you'll ever take and that interest rates will only rise, consider the possibility of refinancing. If refinancing isn't necessary, that's wonderful! But if it is, be grateful you didn't spend money on points when lower rates are available. With more equity, you'll have greater savings when the chance to refinance arises. Since you never paid points, there's no recovery period to worry about.

Thumbs Down to Additional Principal:

• Post Closing Liquidity: Managing your finances requires balance, especially since increasing your down payment can decrease your liquid reserves. Many people overextend themselves with a large down payment, only to later take out a second mortgage or home equity loan soon after. While accessing your equity might be necessary at times, it's important not to treat your new home as the closest ATM.

• Higher for Longer: Unlike buying points, decreasing the principal doesn't reduce the interest rate, but it does decrease the relative interest expense. A higher market rate might make you highly sensitive to rates if your non-housing expenses rise due to your homeowner responsibilities.

Lessor of Evils?

• Short-Term vs. Long-Term: If planning to stay in your home long-term, purchasing points may offer more savings over time. However, if planning to sell or refinance, reducing the principal might be preferable for quicker savings and greater flexibility.

• Your Cash Flow: If you have available cash and can manage the upfront cost, purchasing points could lower your monthly payment. Conversely, if you prefer to keep cash for other needs, reducing principal might be a better choice.

The answer, is not in the stars...

Most things in life boil down to the numbers. Let's walk through this using a loan amount of $200,000 with a 30-year fixed rate. For comparison, let's consider a market rate of 7.0% for a 0 point loan and a 6.5% rate that costs 2 points. We'll examine the difference in monthly payments and the total payout over 30 years. As noted above, the average mortgage lifespan is between 6 and 10 years, so we'll check the balance after 5 and 10 years. Then, we'll determine how long it would take to break even on the 2-point (2%) investment of $4,000. Is it better to invest the money in the lower rate or in your principal?

• Comparison of Mortgage Payments:

  • At 7.0% interest:

    • Monthly Payment: $1,330.60

    • Total Interest Paid Over 30 Years: $279,017.80

  • At 6.5% interest:

    • Monthly Payment: $1,264.14

    • Total Interest Paid Over 30 Years: $255,088.98

  Key Differences:

  • The 0.5% decrease in % rate lowers the monthly payment by $66.46.

  • Over the life of the loan, the total interest savings is $23,928.82.

  • 7.0% costs nothing, the 6.5% rate costs $4,000.

    • net savings is $19,928.82

  • The recovery period of the 2 points is exactly 60.19 months.

• @ 7.0% the balance in 5 and 10 years time is $188,263.18 and $171,624.77.

• @ 6.5% the balance in 5 and 10 years time is 187,221.95 and $169,552.25.

  • 60 months later the balance is lower by $1,041.23 but cost you $4,000!

• What IF?

  The comparison shows that lower rates are effective. For every 1/8th of a percent decrease, the monthly payment drops by $16.62. Instead of applying the points to lower the rate to 6.5%, consider using them to reduce the principal and keeping the 7% rate. Instead of borrowing $200,000, use your $4,000 to borrow a reduced amount of $196,000. Let's examine the results.

  • At 7% interest and $196,000 loan amount:

    • Monthly payment is now $1303.99

      • this saves you $25.90 versus the $200k loan

    • Total Interest Paid Over 30 Years: $273,437.44

      • 5 year balance is $184,497.92

      • 10 year balance is $168,192.37

It is clear that increasing your down payment benefits your payment, interest, and balance compared to the $200k at 7%. Additionally, compared to the $200k at 6.5%, while the payment doesn't improve, your equity position in 5 and 10 years is stronger. Therefore, if a lower rate environment becomes available in the next 5 years, by 2030, what strategy best utilizes your $4k? Refinancing at a lower rate offers more opportunities and quicker benefits. Since there is no recovery period for prepaid interest, you can refinance anytime the numbers present a better scenario than your current one.

Before we exit state right, consider if the increase in down payment will help your "Loan-To-Value," possibly lowering...

• the interest rate, points, fees - closing costs?

• the Mortgage Insurance, if applicable?

"There is nothing either good or bad, but thinking makes is so."

- William Shakespeare