When navigating the mortgage application process, one term that frequently surfaces is "buying points” (AKA “rate buy-downs” or "discount points"). Despite its prevalence, many homebuyers remain unclear about what buying points entails and how it can impact their mortgage rate and overall financial strategy. Here at Murray Mortgage Solutions, we believe in transparency and education, ensuring our clients make informed decisions. In this article, we'll delve into the concept of buying points, the tactics some lenders use to obscure their real cost, and the critical importance of running a break-even calculation.
What Are Mortgage Points?
Mortgage points, also known as discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate. This process is commonly referred to as "buying down the rate." Buying down the rate via Points lowers the interest rate by a certain factor depending on the lender and market conditions. You can buy Points to reduce your interest rate, or you can opt for a higher rate to obtain a Lender Credit to help cover your closing costs.
The terms "points" and "basis points" are commonly used in finance and economics to describe changes in percentages, particularly in the context of interest rates, mortgage loans, and other financial metrics. 1 Point equals 1 % of the loan amount and 1 Basis Point equals .1% of the loan amount. For example, 1 Point on a $400,0000 Loan equals $4,000 and 1 Basis Point equals $40.
What Is Mortgage Rate Pricing?
The relationship between the Interest Rate and Points is generally referred to as Rate Pricing within the mortgage industry. Below is an illustration of a hypothetical Rate Pricing Chart for a $400,000 loan. The rate at which the Points equal zero (or closest to zero) is called the Par Rate (highlighted green). The negative points starting at 6.99% indicates a Lender Credit.
Hypothetical Rate Pricing Chart ($400,000)
When analyzing a Rate Pricing chart, it's important to understand the following:
Power of Interest Rates: You can see how even slight increases in the Interest Rate offer significant Lender Credits you could use to cover your Cash to Close. This is why you should always be mindful of Lenders offering to cover parts of your Closing Costs since they might be baking it into the rate. Keep in mind this example is for only a $400,000 loan, the higher the loan amount, the more impact the rate will have on the Market Pricing scale.
Incremental Impact: In the Interest Rate column, you can see how it changes in increments of .125% but the Points/Credit amount per incremental change aren't constant. This is why when we have our Pre-Approval Review meeting, we will run the numbers on various Point Buy down scenarios to see the impact of each.
Market Fluctuation: Most people understand that Rates change daily, sometimes even several times daily. However, what's changing is actually the Market Pricing. Therefore, not only can the Par rate itself change by the time you're ready to Lock but also the cost for certain level of rate buy-downs. This is why we revisit the Market Pricing together before locking a rate to make sure you take advantage of the best option.
Hidden Points in Advertised Rates
One of the deceptive practices in the mortgage industry involves how some lenders and banks advertise their mortgage rates online. Often, the rates you see advertised are not the rates you would receive unless you purchase points. They also apply to specific loan scenarios which are usually hidden deep in the Disclosures section. This tactic is designed to attract consumers, creating an illusion of lower borrowing costs to get them in the door.
Here's how they do it.
Teaser Rates: Lenders advertise an attractive interest rate that appears to be a great option. This rate usually includes the assumption that the borrower will buy multiple points.
Obscure Conditions: The advertised rate is conditional upon the borrower meeting specific criteria, such as a high credit score, a substantial down payment, specific property type, occupancy type or choosing a particular loan term. They base it off a best-case scenario which you may not fall into.
Foot in the Door: Consumers, drawn by the attractive rate, contact the lender to apply for a loan.
Revised Estimates: During the application and/or underwriting process, the lender reveals the true cost of securing the advertised rate, including the significant upfront payment for points. Due to the complexities of purchasing a home and the sensitive timeline that comes with closing the deal, the borrower will often stay with the same lender anyways.
The Importance of Break-Even Calculations
Before deciding whether to buy points, it’s crucial to perform a break-even analysis. This calculation helps determine whether the upfront cost of purchasing points is worth the long-term interest savings. The break-even point is the time it takes for the savings from the reduced interest rate to equal the cost of the points. At Murray Mortgage Solutions, we have tools for you to instantly compare the cost benefit analysis of buying points compared to locking the Par Rate. During your Pre-Approval review meeting, we’ll go over this extensively.
How to calculate the break-even point:
1. Determine the Cost of Points: Calculate the total cost of the points. For instance, if you buy two points on a $200,000 loan, the cost is $4,000.
2. Calculate Monthly Savings: Determine the difference in the monthly mortgage payment with and without points.
3. Break-Even Calculation: Divide the cost of the points by the monthly savings to find the break-even period.
Example Calculation:
- Loan Amount: $200,000
- Cost of Points: $4,000 (2 points)
- Original Rate: 4%
- Reduced Rate: 3.5%
- Monthly Payment at 4%: $954.83
- Monthly Payment at 3.5%: $898.09
- Monthly Savings: $56.74
Break-Even Period: $4,000 / $56.74 ≈ 70.5 months (approximately 5.9 years)
In this example, it would take about 5.9 years to recoup the cost of the points through monthly savings. If you plan to stay in the home longer than this period, buying points could be a financially beneficial decision. Our tools will also show the interest savings over various time frames such as 5,10,20 and 30 years along with the hypothetical future value savings if you were to re-invest the saved interest each month over the life of the loan.
Other Factors to Consider
While the break-even calculation provides a clear metric, other factors should also influence your decision:
Duration of Homeownership: If you plan to sell or refinance the home before reaching the break-even point, buying points may not be worthwhile.
Available Cash: Ensure you have sufficient funds to cover the cost of points in addition to other closing costs and reserves.
Market Conditions: Interest rates fluctuate based on broader economic factors. Locking in a lower rate with points can provide stability against future rate increases.
Loan Terms: The benefits of buying points can vary significantly depending on whether you have a fixed-rate or adjustable-rate mortgage.
Conclusion
At Murray Mortgage Solutions, we are committed to demystifying the mortgage process and providing our clients with the knowledge they need to make the best financial decisions. Understanding the intricacies of buying points and conducting a thorough break-even analysis are essential steps in evaluating whether this option aligns with your long-term financial goals. If you’re interested in a true rate quote with someone you know and trust, please visit our Rates page or click here to Apply.
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