To decide whether or not to pay points
you will want to compare the options:
- Calculate the cost of the points.
Example: 1 point on a $100,000.00 loan is $1,000.00
- Calculate the monthly savings on
the loan as a result of obtaining a lower interest rate. Example:
$25.00per month
- Divide the 1 point/ $1,000.00 by
the $25.00 monthly savings to come up with the number of months to
break even. In this example, it would take 40 months or 3.33 years to
break even. If you plan to keep the house for longer than the
break-even number of months, then it makes more sense to pay points;
otherwise it does not.
- The above calculation does not take
into account the tax advantages of points. When you are buying a house
the points you pay may be tax-deductible and you realize some savings
immediately. On the other hand, when you get a lower payment, your tax
deduction reduces. This makes it a little difficult to calculate the
true break-even point. In the case of a purchase,
any tax benefit could definitely reduce the break-even time. However,
in the case of a refinance, the points are not immediately
tax-deductible but may be amortized over the life of the loan. It is recommended that you
always consult your tax advisor for advice in any tax related mater.
If none of the above makes sense, use
this simple rule of thumb: If you plan to stay in the house for less
than 3 years, do not pay points. If you plan to stay in the house for
more than 5 years, consider paying points and you will save more money
long term.
Does a "No Cost" loan really exist?
Whatever happened to the conventional
wisdom of waiting for the rates to drop 1 to 2% before refinancing?
Say you have a 30-year fixed loan at
7.5%. A loan officer calls you up and says they can refinance your
mortgage to a rate of 7.0% with no points and no fees whatsoever.
What a dream come true! No appraisal
fees, no title fees and not even any junk fees! Is this a deal too good
to pass up? How can a bank do this? Doesn't someone have to
pay? Whose money is being used to pay these closing costs?
No––this is not a scam. Thousands of
homeowners refinanced using zero-point/zero-fee loan options. Some
refinanced multiple times over the past several years riding rates all
the way down to the historical lows we saw a few years ago.
The way this works is based on rebate
pricing. (Point credit) The basic idea is that instead of paying points
to lower your rate you instead pay an even higher rate in exchange for getting
points back, which are then used to pay the closing costs. You will
always pay
a higher monthly payment if you decide to pay no upfront loan costs. You see
the money you initially save is really coming from higher future loan
payments because you chose a higher interest rate in exchange for no
upfront costs.
For example, a 30-year fixed loan may
be available at a retail price of :
5.0% with 2 points (cost)
5.5% with 1 point (cost)
6.0% with 0 points or
6.5% with -1 point (credit towards closing costs)
7.0% with -2 points (credit towards closing costs) = *No-Cost Loan*
What are the benefits of a
zero-point/zero-fee loan?
The main benefit is that you have no
out-of-pocket costs. As a result, if the rates drop in the future, you
could refinance again even for a small drop in rates.
Zero-point/zero-fee loans are
especially attractive when rates are declining or when you plan to sell
your house in less than 2 years.
The zero-point/zero-fee loan
eliminates the need to do a break-even analysis since there is no
up-front expense that needs to be recovered. It also is a great way to
take advantage of falling rates.
What are the disadvantages of a
zero-point/zero-fee loan?
The main disadvantage is that you are
paying a higher rate than you would be paying if you had paid points and
closing costs. If you keep the loan for long enough, you will end up
paying a lot more––since you have higher mortgage payments.
Zero-point/zero-fee loans may not be
around forever. Lenders are starting to implement pre-payment penalties
to such loans. Lenders do not want to finance properties that are either
listed for sale or are being purchased for immediate resale. Buying a
home to renovate and immediately resell is called Flipping and this
practice is not acceptable by most lender's guidelines.
