When shopping for a mortgage, one needs to know and understand their specific goals, and this should be done even before you start to look at a home or speak to a loan officer. The reason being is because there are several ways of looking atzero points, in which some advertise with no points or no costs, and if you should pay points for your interest rate.
The first step is to have a list of your short term and long term goals. Not only should you know your goals, but your loan officer should be asking about your goals.
Below is what I consider to be the most important questions that should be asked in the first 5 to 10 minutes.
- What mortgage payment would you feel comfortable with. (not the max amount that you could be approved for)
- What are your goals, short term and long term.
- And I ask questions about their assets. Ie. : checking account, 401-k, or if they could get a gift.
Having answers to these questions, I can formulate some game plans on how to utilize the borrower's assets to best help them out now and in the future. Keeping in mind that things do change later on in life, that we don't have crystal balls. I also make sure the borrower is aware of this.
I do want to point out one thing. There are some borrowers that just know what they want. Some will call up and say, "I want Zero points" and or "those no cost loans". Just because the borrower says that they want this type of loan, doesn't mean that it fits their needs. I love to explain, to educate, and to show in comparisons.
Here is an example of paying points or not paying points, aka no points or zero points.
In this example, there are $930 in standard lender closing costs. You would be paying these out of pocket with the lower interest rate of 4.75%, so I included these fees in the total points. With the higher rate, I am including the fees in the interest rate. This means that you are paying the lender fees in the rate and not extra monies at the closing table. I could show you this example with the fees outside the rate, but I wanted to make a point on how to get the best bang for your buck.
As you can see, comparing basic apples to apples, it would take you 7.76 years to recoup the points just from the monthly savings. What some loan officers fail to show are the total savings from different categories. You need to look at :
- Your monthly savings
- Difference in principal remaining
- Tax write off on the points paid at closing
- Tax write off on the interest
Here are why goals are important. In my example below, let's say your goal is to live in the house for 5 years. I am also using a tax bracket of 28 percent for income tax purposes.
Your real break even point after all the variables is 5 years.
Sometimes these scenarios are tough to show, because the interest rates have been ever changing. And because the spread between each 1/8 th of a percent is normally 3/8 th's of a point, but the interest rates have not been reflecting that in the last few weeks to a month. For example purposes, I am not going to get into the details. The main focus point should be that your loan officer should compare several scenarios on your behalf, making sure that you are using your money wisely.
Conclusion : Over the years, I have heard many rumors that paying points to lower your interest rate costs you more money, which is why some lenders talk you into a higher rate. Some times they can make more money on the back end. If you have the money or can get a gift, know your goals, and have a very good idea on how long you will be in the house... as you can see, it pays off down the road.
Disclaimer - Everything mentioned above is of my opinion and knowledge with 18 + years experience in mortgage lending. Please consult your CPA or Tax Accountant.
Colleen Craig wrote this excellent post on no cost mortgages. Myths on No Cost Loans - The bottom line is that every lender and or bank will get it from you one way or another. Hence why I prefer having the borrower pay points and no lender costs.
UPDATE : @ 6:47 pm - You need to read the whole post and the charts. On the surface, it looks like you break even in 7.76 years, but after reviewing all of the categories to look at, your actual break even point is 5 years... and that I am including the lender costs in the total scenario. I will say this.. if you went back about 6 months and longer, the breakeven point usually comes out to 3.5 to 4 years. Why? Because some coupons for lower rates would be cheaper. But it's to expensive to drop to 4.625% right now. FYI..