This is a topic I touch on or repeat at least once per year b/c borrowers continue to ask us if they “should buy down their rate,” and our answer is almost always “no.”
EVERYONE WHO PAID POINTS IN 2009 WASTED THEIR MONEY
In 2009, when rates fell below 5% we refinanced our entire database and many borrowers wanted to pay points to buy down their rate.
As a reminder – a “point” is 1% of the loan amount.
Our borrowers wanted to pay points b/c: (1) they thought rates had hit an all-time low and they wanted the lowest possible rate; and (2) a point could buy the rate down as much as 1/2 percent (much more than usual) at that time.
BUT – within a year rates had fallen significantly again and every one of those points-paying borrowers ended up refinancing again.
Hence, the points they paid were a total waste of money. Ever since that experience, we have been advising against paying points.
WHY WE DON’T RECOMMEND POINTS/BUYING DOWN RATES
- Too Little Bang for the Buck: In the current market, borrowers typically only get about a 1/4 percent improvement in rate for paying a point. Hence, it takes about four years to recoup that point with interest savings. Borrowers often end up refinancing before they recoup their points, as discussed above and below.
- Changing Rates, Changing Equity and Life Events: No matter how long people expect to keep their loans, we are always amazed by how soon they refinance for a variety of reasons, including the following:
- Rates fall sooner than expected (like what has happened over the last several months);
- The equity in their home increases and they want cash out or they want to eliminate Mortgage Insurance; and
- Life events such as job changes or family size changes require different housing needs.
- Fed Can’t Raise Rates/Weak Economy: The Fed has tried to push rates to the lowest level ever in order to combat economic damages caused by the COVID-19 crisis. The Fed is not the sole driver of mortgage rates, as I mention often, but it does still influence rates in a significant way. Moreover, the Fed’s hands now seem tied in that it has to keep rates low in order to keep asset prices inflated.
- Rates Could Fall Further As Mortgage Industry Stabilizes: Mortgage rates are currently higher than where they otherwise might be b/c of major issues within the mortgage industry, including: (1) too much business/too little capacity; (2) excess risk b/c of the COVID-19 crisis and other factors; and (3) lower valuations for servicing rights. As these issues dissipate, we could see rates fall further. The “spread” between the 10 Year Treasury and mortgage rates remains about 1% higher than normal, as I mention often.
- Unscrupulous Lenders: Many lenders convince borrowers to pay points for rates that they probably could have obtained at “no points” at another lender. These lenders convince borrowers that they are paying “discount points” to buy down the rate when the borrowers are really just padding the lenders’ overall commission.
- Cash Is King: One more reason not to pay points is that it requires more cash to close, and for many of our borrowers, cash is all too tight in the first place. In addition, it is simply advisable to remain more liquid for a variety of reasons – home improvements, investment opportunities, unexpected expenses, lay-offs, etc.
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Founder/Broker | JVM Lending
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