Buying Down Interest Rates: A Guide for Homebuyers

What are Points, and Why Buy Them?

Buying down interest rates, also known as buying points, may seem counterintuitive to many people. However, it can be a smart financial move for homebuyers. In this article, we’ll explore the pros and cons of buying down interest rates and help you make an informed decision.

What are Points?

In simple terms, buying points means paying a fee at closing that reduces the interest rate on a mortgage. Typically, each point costs 1% of the total loan amount. For example, each point on a $200,000 mortgage will cost $2,000, while they’ll cost $4,000 per point on a $400,000 loan.

How Much Can Buying Points Save?

If reducing an interest rate by one-quarter of a percent doesn’t sound like much, consider this: On a $200,000 mortgage, the difference between a 7% and a 6.75% mortgage payment is about $33 monthly. This might sound relatively insignificant, but the long-term savings are substantial.

On a 30-year mortgage with a 7% interest rate, clients pay just over $279,000 on interest alone. With a 6.75% rate, they’ll pay just over $266,000. That’s a net of $11,000 in savings over the life of the loan from just $2,000 upfront.

Pros of Buying Down Interest Rates

For many clients, spending a little extra at closing is an excellent idea. Here are four pros of paying points:

1. Monthly Payments are Lower: A lower interest rate means lower monthly payments over the life of the loan. If clients are looking for more cash flow and less of a monthly burden, this can make payments more manageable.
2. Less Interest Paid Over Time: Paying points is a positive strategy if your clients are looking for their forever home. A reduction in the monthly mortgage payment of just $30 or so may not seem much, but stretch it over the life of the loan, and the savings are substantial.
3. More Tax Deductions: Mortgage points may be tax deductible, which offsets some upfront costs and can offer financial relief at tax time. Remember that tax rules are complex, and not all homebuyers can take advantage of this benefit. Advise your clients to consult their tax professional if they have questions about their personal tax situation.
4. Loans May be More Affordable: In a tight market with inventory still relatively low, many buyers find themselves in the uncomfortable position of stretching their monthly budgets to make a competitive offer. In this case, buying down interest rates can help ease that tension. This flexibility is also ideal for anyone looking to move to a larger property or to be more competitive in the bidding process.

Cons of Buying Down Interest Rates

Not everything falls in the positive column when it comes to buying points. Here are three cons to share with your clients:

1. Clients Pay More at Closing: The upfront cost increases the initial total cost of the loan, which means the amount due at closing can be larger than expected. This expense can be burdensome for clients who need cash for down payments, moving expenses, or other closing costs.
2. It Takes a Bit to Break Even: Recouping the costs of paying points typically takes several years at a minimum, with the exact break-even point depending on the loan amount, the number of points paid, and how much money clients save on their monthly payments. If clients sell or refinance too soon, some or all of the benefits are wasted.
3. Risk of Unexpected Changes: Even if clients plan to stay in their homes well past the break-even point, predicting the future is impossible. Unexpected life changes, from a job change to a death in the family, can cast even the best-laid plans aside and force clients to move or refinance. There’s no need to dwell on potential disasters, but it is vital to let clients know they may lose the advantage of points in these unfortunate situations.

Should Your Clients Buy Down Interest Rates?

As mortgage rates increased in 2022 and 2023, the proportion of homebuyers paying discount points doubled, according to studies by the Consumer Financial Protection Bureau and Freddie Mac. Last year, nearly 2 out of 3 borrowers taking out purchase loans paid points to lower their rate.

While discount points are often paid by the borrower, homesellers and homebuilders may also offer to buy down the homebuyer’s interest rate. These incentives are often offered in the form of temporary rate buydowns that only last one to three years.

Not every client will benefit from buying points. But with 70% of homesellers worried that higher interest rates will deter buyers, it’s critical for real estate agents to give homebuyers all the tools they need to make informed decisions about them.

Conclusion

Buying down interest rates can be a smart financial move for homebuyers, but it’s essential to weigh the pros and cons carefully. With the right information and guidance, clients can make informed decisions about whether buying points is right for them.

FAQs

Q: How do I know if buying points is right for me?
A: Consider your financial situation, your plans for the future, and the benefits of buying points. If you plan to stay in your home for several years, buying points may be a good idea.

Q: How much do points cost?
A: Typically, each point costs 1% of the total loan amount. For example, each point on a $200,000 mortgage will cost $2,000, while they’ll cost $4,000 per point on a $400,000 loan.

Q: Can I buy more than one point?
A: Yes, but many lenders won’t sell more than four points. For that same $200,000 loan at an original 7% rate, four points would cost $8,000.

Q: Are there any tax benefits to buying points?
A: Mortgage points may be tax deductible, which offsets some upfront costs and can offer financial relief at tax time. However, tax rules are complex, and not all homebuyers can take advantage of this benefit.

Author: www.inman.com

Orginal Source link