Ahh, good ole points. Often people ask about points without truly understanding what they are or how they can help or hurt you. Points are essentially our industry’s way of saying percentage points. They are used for one reason; to compensate the lender for writing the loan. Now, some say you can “buy down” the rate with points. Believe it or not there is not a Sam’s Club for mortgage rates that I have special card to get into where if I have enough points I can snatch up that 2.0% for your particular loan… and even if there were I would still write this and never admit to it. Some lenders are afraid to admit that in some way they too are compensated, but if you look logically at the situation a lender has costs that must be met (i.e. keeping the lights on, paying employees, golf, champagne, cigars, normal stuff…) and a lender can be compensated in one of two ways, points or on a yield spread. Points pay the lender right up front, while a yield spread is essentially the money a lender makes for a specific rate of interest on your loan. “Buying down” a rate simply means that since you are getting the lower rate the lender can’t make any money on the rate so there will be points on the loan. Clear as mud? Maybe this will help…
Lets look at an example to see how “buying down” a rate could make sense.
For instance 1 point represents 1% of a loan amount. So if you have a loan for $100,000 and you are being charged 2 points, you are being charged 2% of $100,000 or $2,000. The best way to analyze whether it is worth it to pay points is to perform a break-even analysis. Let’s use the numbers from above:
Scenario: Paying 2 points on a $100,000 loan gets you the rate you want, so you are paying $2,000.
Step 1: Calculate how much monthly it will save you to lower the rate; let’s say it saves $50 per month.
Step 2: Divide the cost of the points by the monthly savings to come up with the number of months to break even.
Step 3: In this case $2000/$50 = 40 months. So if you plan to keep the home for longer than 40 months, then there is a valid argument for paying points.
So if you find yourself in the same situation as above then it may make sense for you to pay the points if you intend to stay in the home for the next 3 ½ years. Although, some people may choose to keep the $2,000 in the bank and pay a little extra each month on their mortgage. That is why it is not a black and white topic, there is some grey in there and each situation is a bit different. Generally, I don’t suggest paying points and rarely do my clients pay them, but again every situation presents its own set of unique circumstances. Contact Me if you are curious if it will make sense for you.
And remember that the next time you hear a radio ad from Billy Joe Bob’s House of Mortgages that says they can get you a rate that seems ridiculously low and throw in a 32” flat screen; just know that Billy may be looking to tack some points on there and that the flat screen is probably not a Sony… or really even all that flat.
-Matt Brown
