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For many people, lowering interest rates (also known as point-to-purchase) may seem counterintuitive. After all, why would a home buyer be willing to commit more cash or sign a larger loan at closing?
In fact, there are some good reasons to consider lowering your interest rates, but there are also reasons why it might not be a good idea. It is the attorney’s responsibility to help clients understand which side they fall on by explaining the important pros and cons.
What are points and why should I buy them?
Simply put, buying points means paying a fee at closing, which results in a lower interest rate on your mortgage. Typically, each point costs 1% of the loan amount, making pricier properties more expensive. For example, a $200,000 mortgage would cost $2,000 per point and a $400,000 loan would cost $4,000 per point.
How much buying points will lower your interest rate depends on the lender and your unique situation, so it pays to compare offers from different lenders. While one lender may lower your interest rate by 0.25 percentage point for every point you purchase, other lenders may offer greater or smaller rate reductions.
When comparing quotes, Consumer Financial Protection Bureau advises Ask each lender for the same number of points. Points don’t have to be whole numbers—you can pay fractions of a point, such as 1.375 points or 0.125 points.
Some buyers pay points upfront and write a check at closing, while others roll the cost into the mortgage. Each approach is possible, but adding the cost of points to your mortgage means you’ll also be paying interest on the points over the life of the loan, reducing the buyer’s potential savings.
Do not confuse discount points with origination points. The starting point is the fee charged by the lender to create the loan. They’re just another closing cost that doesn’t impact long-term recurring costs.
Borrower’s Points loan estimate and end disclosure Must be tied to discounted rates.
How many points can you save on your purchase?
If lowering your interest rate by a quarter doesn’t sound like much, consider this: For a $200,000 mortgage, the difference between a 7 percent and a 6.75 percent mortgage payment is about $33 per month. This may sound relatively trivial, but the long-term savings are huge.
For a 30-year mortgage with an interest rate of 7 percent, the customer would pay more than $279,000 in interest alone. At an interest rate of 6.75%, they would pay just over $266,000. That means you can save $11,000 in net savings over the life of the loan by just putting $2,000 down.
There is no official limit on how many points a customer can purchase at closing, but many lenders won’t sell more than four points. For the same $200,000 loan with an original interest rate of 7%, four points would cost $8,000. Lower interest rates by 2% and buyers will pay more than $92,000 less in interest over 30 years than they would otherwise.
Calculating whether the points are worth it depends on whether the customer plans to stay in the home long enough to recoup their investment and start reaping savings.
Advantages of Buying at a Lower Interest Rate
For many customers, spending a little extra at checkout is a good idea.
Here are four advantages of paying points:
1. Lower monthly payments
A lower interest rate means lower monthly payments over the life of the loan. This can make payments more manageable if customers are looking for more cash flow and less monthly burden. It also frees up income for improvements and maintenance, which is essential if the property is an investment investment.
2. Interest paid decreases over time
If your clients are looking for their forever home, paying points is a positive strategy. A $30 or so reduction in your monthly mortgage payment may not seem like much, but over the entire term of your loan, the savings can be substantial.
3. More tax breaks
Mortgage points are tax deductible, which can offset some of the upfront costs and provide financial relief when tax time comes. Keep in mind that tax rules are complex and not all homebuyers will be able to take advantage of this offer. If your clients have questions about their personal tax situation, recommend that they consult a tax professional.
4. Loans may be more affordable
In a tight market where inventory remains relatively low, many buyers find themselves in the awkward position of needing to increase their monthly budget to make a competitive offer. In this case, lower interest rates could help ease the tension. This flexibility is also ideal for those who want to move to a larger property or be more competitive during the bidding process.
Disadvantages of Buying at a Lower Interest Rate
When it comes to point-of-purchase, not everything falls into the positive category.
Here are three drawbacks to share with your customers:
1. Customers pay more at closing
Upfront costs add to the total initial cost of the loan, which means the amount due at closing may be higher than expected. This fee can be a significant burden for customers who need cash for a down payment, moving expenses, or other closing costs.
2. It takes a while to break even
Recovering the cost of paying points usually takes at least a few years, with the exact break-even point depending on the loan amount, the number of points paid and the amount the customer saves on their monthly payments. If a client sells or refinances prematurely, some or all of the proceeds are wasted.
3. Risk of unexpected changes
Even if customers plan to stay in their homes beyond the break-even point, predicting the future is impossible. Unexpected life changes, from a job change to a death in the family, can put even the best-laid plans on hold and force clients to move or refinance. There’s no need to dwell on potential disasters, but it’s crucial to let customers know they may lose points advantage in these unfortunate circumstances.
Should your client lower their interest rate?
As mortgage rates rise in 2022 and 2023, the share of homebuyers paying discount points doubles, according to research. Consumer Financial Protection Bureau and Freddie Mac. Last year, nearly two-thirds of borrowers paid points to lower their interest rate when purchasing a loan.
While discount points are typically paid by the borrower, home sellers and home builders may also offer to lower the homebuyer’s interest rate. These incentives are typically provided in the form of: Temporary interest rate cut This only lasts one to three years.
Not every customer will benefit from purchasing points. But with 70% of home sellers Amid concerns that higher interest rates will deter buyers, real estate agents must provide homebuyers with all the tools they need to make an informed decision.
While buying points can sometimes come with significant upfront costs and risks, they can also make homeownership more affordable in the long run. If a client is still unsure, a financial advisor can provide more specific advice based on their specific circumstances.
