When should a Borrower Pay Points?

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Mortgage and Lending with Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, NMLS #138061 MMCD #1141
https://activerain.com/droplet/4qFj

When Should a Borrower Pay Points?

 

 

     "Points".  One of the most oft-spoken terms when speaking with borrowers about their mortgage application.  Also one of the most misunderstood concepts that borrowers have with the mortgage industry.  I blame the media for this.  I also blame lenders & loan officers for not effectively communicating just how much has changed in our industry over the past few years.  I also blame Realtors & financial advisors for not fully understanding the concept yet still offering advice, advice that often gets stuck in a borrowers head & leads them to make poor financial decisions.  Let's break it down and see if I can explain "points", when they're necessary, and when they should be avoided (it would come as a surprise to most that the answer to 'when they should be avoided' is NOT "always")

 

 

     A "point" in the mortgage industry, on its most basic level is easy to understand.  Quite simply, 1 point is equal to 1% of a borrowers loan amount.  A half point?  Half a percent.  On a $100,000 loan, 1 point is $1,000.  On a $500,000 loan amount, 1 point is $5,000.  Simple enough, right?

 

 

     Where things get a little confusing is how points are applied.  Some points are pure profit for the lender.  Some points are part of a long term planning strategy for borrowers.  All points are not created equal.

 

 

     Since the implementation of the Dodd-Frank act, points no longer directly affect an individual loan officer's compensation since that compensation is now a fixed % of each loan, but points still affect lender's rate sheets and how pricing is offered to consumers.  They're still very much a part of important discussions when it comes to how a mortgage fits into a borrowers financial plan.  Find a lender that offers rates much lower than anyone else?  Chances are, you're paying that lender points to afford them the luxury of those low rates.  Find a lender with incredibly low fees and lender credits?  Chances are there are points padded into their interest rates.

 

 

     The majority of lenders these days deal primarily with discount points, so that's where I'll keep my focus.  A discount point is a fee that buys down a borrower's rate.  Though rates and spreads vary each day, in a typical scenario, the amount a rate is decreased is usually .25 for 1 point.  So if the market is offering a rate of 4.25%, a borrower could likely get a 4% by paying somewhere around 1% of their loan amount as an up front fee at closing.  This is not a symbiotic relationship so cost/amount saved can vary greatly.

 

 

When should discount points be paid?

 

 

     When planning long term, discount points can be a real benefit.  For example, take someone buying their 'forever home' with a 30 year fixed rate loan.  Just for this example, let's say it's a $300,000 loan.  For 0 points, they can get a 4.5%.  For 1 point, they can get a 4.25%.  The discount point in this scenario is $3000 and the monthly savings is only $45/month, BUT, long term, the amount of interest paid for the lower rate offers a savings of nearly $16,000.

 

     Is $13,000 over 30 years (the total savings taking the $3000 up front into account) going to be a life changer?  Maybe not, but what about the person that does this on 4 or 5 properties?  Those savings add up in the grand scheme of financial planning.

 

 

     When spreads are low between rates, borrowers can also take advantage and pay discount points.  Sometimes the bond market brings about rate sheets where buying down a rate with discount points doesn't cost as much as usual.  For example, it might only cost a half point to get a .25 reduction to rate.  Many times it makes sense to buy the rate down in this situation.  When this opportunity arises is usually just dumb luck when rates are in the midst of large fluctuations and volatility (some lenders will be uncertain on which rate to price most competitively, and the result can be several rates priced competitively).

 

 

     When points are being used to avoid PMI.  I often use this strategy when using the LPMI program to avoid a costly monthly burden for borrowers, while also avoiding the permanency of a higher rate that comes along with most LPMI programs.

 

 

When should you avoid points?

 

 

     Any time a loan is short term, paying points doesn't make sense (unless it's the LPMI scenario above and the numbers work out, a good Loan Officer will be able to help with the numbers). 

 

 

     In many cases, it makes more sense in a short-term situation to take a higher interest rate and have closing costs paid for by the lender...but that's another blog for another day.

 

 

     The "point" is, when beginning to shop for a mortgage, borrowers should avoid 2 thoughts - "I want the lowest rate" and "I'm not paying any points".  Points are no longer used by lenders to gouge customers like they were in the past.  Points play a role in financial planning and obtaining the best mortgage, and should always be discussed with your lender.  Maybe the lowest rate is best for you, or a loan with no points, but maybe a couple discount points could save you a ton in the long run, or a higher rate will benefit you most.  Work with your trusted loan officer, and you just might be surprised at which options work best with your plans.

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Re-Blogged 5 times:

Re-Blogged By Re-Blogged At
  1. Lynn B. Friedman 11/04/2014 10:50 AM
  2. Joy Daniels 11/04/2014 09:48 PM
  3. Gary L. Waters Broker Associate, Bucci Realty 11/05/2014 01:36 AM
  4. Lenn Harley 11/06/2014 08:00 PM
  5. Ritu Desai 11/06/2014 09:03 PM
Topic:
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Groups:
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The Lounge at Active Rain
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Tags:
points
closing costs
mortgage fees
discount points
origination points
mortgage points
shopping for a mortgage

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Rainmaker
1,007,234
Rob Arnold
Sand Dollar Realty Group, Inc. - Altamonte Springs, FL
Metro Orlando Full Service - Investor Friendly & F

Excellent explanation on points.  What you say makes a lot of sense.  I always thought points should only be paid if the loan was going to be open for many years, but you gave me several new reasons. 

Nov 04, 2014 10:25 PM #23
Rainmaker
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Sandy Padula and Norm Padula, JD, GRI
Realty National & Geneva Financial, Llc. - Carlsbad, CA
Presence, Persistence & Perseverance

John: Excellent blog on 'Points'. SO many folks ask me about points and my answer has basically been similar; the payback period is crucial.

Nov 04, 2014 11:13 PM #24
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Sharon Paxson
Compass - Newport Beach, CA
Newport Beach Real Estate

Good Morning John - excellent and informative post about points and you have done a great job explaining it here. Thanks and I will book mark this post for future reference.

BTW - thanks for your comment on my Cherry Lake post and if I see something on preview there - I will text you and we can go and see it if you are interested, it is a unique area.

 

Nov 04, 2014 11:19 PM #25
Rainmaker
2,745,138
Kathleen Daniels
KD Realty - 408.972.1822 - San Jose, CA
San Jose Homes for Sale-Probate & Trust Specialist

John, How the points are applied, I feel, is hugely misunderstood – likely because it is not explained. They key here is “Points are no longer used by lenders to gouge customers like they were in the past.”  We need to understand the benefit and value of paying points!

Nov 05, 2014 12:03 AM #26
Rainmaker
1,500,241
Gary L. Waters Broker Associate, Bucci Realty
Bucci Realty, Inc. - Melbourne, FL
Fifteen Years Experience in Brevard County

Excellent explanation of points and when and when they may not be good for the borrower.

Nov 05, 2014 12:55 AM #27
Anonymous
David R Youngs

This is such a common misconception in our industry about what Points really are and how they at times can actually be beneficial to include in your loan structure. Very well written article! I couldn't have explained it any better!

Nov 05, 2014 01:22 AM #28
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John Meussner
Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, - Walnut Creek, CA
#MortgageMadeEasy Walnut Creek, CA 484-680-4852

Praful - I don't think that's bad advice at all - usually if the 'break even' point isn't for 20 years, it may not be worth it as plans change many times over in that time frame - I advise people to look at the 5 year plan and act accordingly.

 

Jon - thanks for the comment, you're absolutely right.  If lenders want to sell a specific program the discount points can come cheap!

 

Joe - thank you for the comment, tried to break it down to the basics as it's often misunderstood.

 

Kat - for a while there some lenders got crazy with points.  The system has become much more equitable (albeit more confusing, too) for consumers in many ways.

 

Nina Hollander buyers/borrowers have such a misconception about 'points' that a lot of lenders are afraid to bring them up for fear of losing a client, even if points would benefit the client!

 

Joy Daniels Would I care?  No, I'd be flattered!  Thanks for sharing, and I'll get to work on that ARM blog (I've got to do some digging to see if I've already written it)

 

Richie - thanks for the comment - that's my favorite part of sales, showing people how things can help them when they're not even aware.

 

 

Nov 05, 2014 02:53 AM #29
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John Meussner
Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, - Walnut Creek, CA
#MortgageMadeEasy Walnut Creek, CA 484-680-4852

Rob - thank you for the comment, glad I could shed some light on ways points can be productively used, hope it helps you show your expertise to your clients.

 

Norm - yes, the time the loan is open is often the factor that determines whether it makes sense, but it's always case by case.  Thanks for the comment!

 

Sharon Paxson thank you, glad you found the post helpful, and Cherry Lake looks like a great spot, I'd love to check it out!

 

Kathleen - YES, "points" is still a scary term to borrowers, but in reality, they're a lot different today than they were 5 years ago.

 

Gary - thank you for the comment and for reading!

 

David - thanks a lot, definitely was trying to clear up misconceptions and allow borrowers to understand how points can benefit them in some cases.

 

Nov 05, 2014 02:57 AM #30
Rainmaker
777,756
Kevin Mackessy
Blue Olive Properties, LLC - Highlands Ranch, CO
Dedicated. Qualified. Local.

Always makes sense when you're dealing with multiple properties.  MY son just bought a condo this year, and it would've taken 10 years to recoup the additional point, had he gone with that.  It wasn't worth it. 

Nov 05, 2014 05:54 AM #31
Rainmaker
2,895,208
Nina Hollander
Coldwell Banker Residential Brokerage - Charlotte, NC
Your Charlotte/Ballantyne/Waxhaw/Fort Mill Realtor

Jon... I think I need to agree with you. In general, I've found that too many lenders don't really go "deep" in discussing options with home buyers.

Nov 05, 2014 09:05 PM #32
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John Meussner
Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, - Walnut Creek, CA
#MortgageMadeEasy Walnut Creek, CA 484-680-4852

Kevin - for younger buyers it often doesnt make sense as they won't keep a property 10+ years.  Unless of course he'd turn it into a rental down the line, then it would be worth considering.  Good to know he weighed his options.

 

Nina - it's the truth.  Many times a client will give me enough info through general conversation that discussing options doesn't really make sense because there's only a program or 2 that would work for them.  But with most borrowers, they aren't aware of all the different options they have.  It's my job to make them aware and help them make the right decision.

Nov 06, 2014 03:03 AM #33
Rainmaker
108,609
Kevin Hancock
Evergreen Home Loans - Poulsbo, WA
The Hancock Mortgage Team

Great explanation John!  I was considering writing something similar myself, but you beat me to it.  The important thing is to analyze the numbers and determine what makes sense in each specific situation.

Nov 06, 2014 07:43 AM #34
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Lenn Harley
Lenn Harley, Homefinders.com, MD & VA Homes and Real Estate - Leesburg, VA
Real Estate Broker - Virginia & Maryland

Points are no more and no less than pre-paid interest.

Pay points now and enjoy a lower interest rate for years.

The key is to amortize those points over the life of the expected ownership to determine if they make sense.

It makes no sense to pay 2-3 points to lower a monthly payment for 3-5 years.  However, if the owner remains in the property for more than 5 years, a point or two to lower the long term interest payment may make sense.

Nov 06, 2014 07:56 PM #35
Rainmaker
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Roger D. Mucci
Shaken...with a Twist 216.633.2092 - Euclid, OH
Lets shake things up at your home today!

Not sure how I missed this, but glad I read Lenn's re-blog.  Excellent post John and great information.  I never understood what points were all about, but do now.

Nov 06, 2014 08:08 PM #36
Rainer
355,882
Tom White
Franklin Homes Realty LLC (615) 495-0752 or www.FranklinHomesRealty.com - Franklin, TN
Franklin Homes Realty LLC, Franklin TN

John, thanks for the great explanation! I know this goes "against the grain" but while it's important to understand these issues, I never give advice on these matters, rather, I leave that to the mortgage lending professionals. There's a danger for agents to think they know enough about financial options to offer advice. In fact, all parties sign a disclaimer that pretty much says, "the agents don't know anything about anything other than bringing the buyer and seller together in a transaction". I simplify here, but you get the idea. There very well be better options available to them that are known by the professional lender--but not by me. I certainly suggest they talk to their lender about their options.  

Nov 06, 2014 10:28 PM #37
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John Meussner
Mason-McDuffie Mortgage, Conventional Loans, Jumbo Loans, FHA, 203(k), USDA, VA, - Walnut Creek, CA
#MortgageMadeEasy Walnut Creek, CA 484-680-4852

Kevin - correct, each situation is different so we need to do our best to show this to our borrowers .  Thanks for the comment, and go ahead and write something similar anyway! Spread the word.

 

Lenn - thank you for the comment, and for 'getting it'.  I've heard so many people say "I was told to not pay any points" when they're looking at their forever home - points make sense sometimes.

 

Roger - thank you, I'm glad it shed some light & you learned something new.  I appreciate you stopping by.

 

Tom White Thank you Tom, you do it the right way!  I often have buyers ask me "should we offer a lower price", and I do the same thing - point them in the direction of their expert, their agent, for the right answer.  I know a little about your side of things, but not enough to have those discussions.

Nov 07, 2014 12:31 AM #38
Rainmaker
795,983
Troy Erickson AZ Realtor (602) 295-6807
Good Company Real Estate www.ChandlerRealEstate.weebly.com - Chandler, AZ
Your Chandler, Ahwatukee, and East Valley Realtor

John, great explaining mortgage points and when paying them down may be beneficial, or when when paying them may not be beneficial.

Nov 07, 2014 10:30 AM #39
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Debbie Reynolds
Platinum Properties - Clarksville, TN
Your Dedicated Clarksville TN Real Estate Agent

Most of the time it doesn't make sense in my market because the buyers are planning on moving in 3-5 years. Plus they don't want to use their cash unnecessarily.

Nov 07, 2014 10:32 AM #40
Rainmaker
581,903
Claude Labbe
Real Living | At Home - Washington, DC
Realty for Your Busy Life

As you correctly point out, it's unusual for all cases to have the same answer.  Here, the answer is more correctly "it depends".

Good thing you can set them straight.

Nov 07, 2014 11:58 AM #41
Rainmaker
1,524,804
Bob "RealMan" Timm
Ward County Notary Services - Minot, ND
Owner of Ward Co. Notary Services, retired Realtor

What a great post John Meussner , thank you so much. May I use this in the news letter I mail out locally?

May 13, 2016 10:57 PM #42
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