Anyone who's ever
shopped for a mortgage has faced the question - - and borrowers who expect to
stay in their homes for some time generally have been advised to pay points in
order to get a lower mortgage rate. But new research turns the conventional
wisdom on its head, showing that for most people paying points is a bad
idea.For the most part, points benefit the lender, not the borrower.
Each point is an
up-front payment equal to one percent of the loan. Paying one, two or three
points gets you a lower interest rate and smaller monthly payment. With points,
we have more choices. If you have the mortgage long enough, that saving will
more than make up for the cost of the points. Once the break-even point is
passed, you're ahead.
It's simple
arithmetic.
For
example, Wachovia advertised a 30-year, fixed- rate loan for 5.5 percent and
1.75 points. After paying $5,250 in points on a $300,000 loan, monthly payments
would be $1,703. The bank also had a 5.875 percent loan with just 0.125 points.
Points on the same loan would be just $375 -- but monthly payments would be
$1,775.
It would take 68
months for the $72 difference in payments to offset the extra $4,875 in points
you'd pay to get the lower rate. After that, the decision to pay points would
save you $72 a month for as long as you had the mortgage. You'd save a whopping
$21,024 if you had the mortgage a full 30 years.
Seems simple enough.
But it turns out that
most people get it wrong.
The problem,
according to the study, is that most homeowners don't keep their mortgages as
long as they expect to when they get them, so they don't reach the break-even
point.
Abdullah Yavas,
business professor at Penn State's Smeal College of Business, and Yan Chang of
Freddie Mac, the mortgage-funding company, looked at 3,785 mortgages granted
from 1996 through 2003.
They found that the
average homeowner paid off his or her mortgage about three years before
reaching the break-even point. Only 1.4 percent of borrowers kept their loans
long enough to make paying points worthwhile. The study also found that
borrowers who declined to pay points almost always made the right decision.
Only 1.5 percent of them would have saved money by paying points. Disturbingly,
borrowers who paid points tended to wait too long to refinance their loans
after rates dropped, missing chances to reduce their mortgage payments.
Apparently, this was because of a mistaken belief they should keep their loans
long enough to "pay off" the points. In fact, the points should not
enter into this decision. All that matters is whether the new mortgage would be
held long enough for the reduction in monthly payments to offset the
refinancing charges.
Points do have their
place. After all, it is possible to save by paying them, if you keep the
mortgage long enough.
But how do you judge
that? I suspect most people focus on how long they expect to keep their home --
until they start a family and need more room, or until the kids move out or mom
and pop retire.
But many of these events
are not as predictable as we think. And then there's another big unknown: Will
mortgage rates rise or fall after you get your loan?
Even if you stay in
your home as long as you'd expected, falling interest rates may make it
worthwhile to refinance. If that happens before the break-even date, much of
what you'd paid for points may have been wasted. It becomes profit for the
lender.
One final factor to
consider: What else could you do with that money if you did "not pay
points?
Taking the example above,
imagine the extra $4,875 that could be spent on points instead was put in a
bank account paying 5 percent. And imagine that if the higher points were paid,
the $72 in monthly mortgage-payment savings could be banked at 5 percent.
This postpones the break-even
date by a year -- to 80 months instead of 68. Since the $4,875 would be
growing, it would take longer for the $72 in monthly savings to catch up.
Branch Manager NMLS #300510
775.832.6522
264 Village Boulevard, Suite 2B
Incline Village, NV 89451
TahoeLending.com
Text ‘Dave’ to 313131 to
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Disclaimer:
The views and opinions expressed on this site about work-related matters are my own, have not been reviewed or approved by Supreme Lending, and do not necessarily represent the views and opinions of Supreme Lending. In no way do I commit Supreme Lending to any position on any matter or issue without the express prior written consent of Supreme Lending’s Human Resources Department.
Branch Manager: David Colarchik
Main: 775-833-7100 | Direct: 775-832-6522 | Fax: 775-833-7108
264 Village Blvd Suite 2B, Incline Village, NV 89451
David.Colarchik@supremelending.com
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