It’s a hard time to be a homebuyer. Prices are still high and home inventory remains at a record low. Another wave in the stormy homebuying seas: rising interest rates. Buyers naturally want to take the sting out of surging mortgage rates, and are increasingly buying discount points on their mortgage. Is this a good option for your clients?
The answer depends on the client. Discount points are fees a buyer pays to reduce their mortgage interest rate and monthly payment. Purchasing discount points can save your clients money in the long-term – but depending on their circumstances, it might be a risky option.
Learn what you should consider when your clients ask about discount points, and what factors to weigh when giving advice about whether your client should “buy down” their rate.
1. How Long Does the Buyer Plan to Stay in the Home?
The first and most important consideration buyers should make when deciding whether to purchase discount points on their mortgage is about the length of time they plan to stay in their home.
Imagine a client who is taking out a $400,000 mortgage loan. The cost of one discount point is typically pegged at 1% of the total mortgage. One discount point knocks .25% off a buyer’s interest rate – currently around 5%.
So, paying $4,000 to reduce that mortgage rate to 4.75% will save a buyer $57 per month. That $57 per month will add up to $4,000 after 70 months – at which point the buyer will have “broken even” on their discount point purchase. The purchase of discount points is only worthwhile when buyers hit that “break even” point.
If this buyer was to sell their house before six years, they will have actually lost money by purchasing the discount point. If they stay in the house for 30 years, they will save $20,520.
In short, the purchase of discount points is dependent on how long a buyer plans to stay in their home. If they only plan to live in a property for three or five years, options such as an adjustable-rate mortgage or making a larger down payment would be preferable. Buyers looking for a “forever” home should more strongly consider discount points.
2. Does the Buyer Intend to Refinance?
Even if a buyer intends to stay in a newly-purchased home for decades, discount points may not be the best option to reduce their mortgage burden. Refinancing, in particular, is sometimes a useful strategy for homeowners that could render discount points worthless.
When homeowners refinance a mortgage, they trade in their current mortgage for a new one, with an updated loan amount and interest rate. Typically, homeowners refinance when their income or credit score increases or when the 30-year fixed mortgage rate decreases – allowing for a more favorable, less costly loan.
Buyers who anticipate substantial increases in their household income or credit score in the next few years typically avoid discount points – they’d rather refinance their mortgage for more favorable rates in the future. Buyers who expect steady income, a comparable credit score, and living in the property for the medium- to long-term will be unlikely to refinance within the first few years of a mortgage, and may benefit from discount points.
All buyers should be warned that refinancing could be difficult for the next few years, as the Federal Reserve raises interest rates to fight inflation, pushing up mortgage rates and the overall cost of borrowing.
3. Is the Buyer Signing an Adjustable-Rate Mortgage?
For buyers agreeing to an adjustable-rate mortgage, purchasing discount points typically isn’t a shrewd move.
Adjustable-rate mortgages (ARMs) offer buyers a lower initial mortgage rate that rises after five, seven, or 10 years. In the early life of the loan, borrowers stand to reap substantial savings. But if they remain locked into the borrowing terms, buyers usually pay more than a standard, fixed mortgage over the course of 30 years.
Adjustable-rate mortgages work best for buyers who plan to sell or refinance in the early stages of a home loan – a marked difference from discount points, which are most useful to buyers who don’t plan to refinance and intend to stay in the property they purchase.
For this reason, ARMs aren’t a hotbed of discount point purchases. Points only pay off if you keep the property long enough to reap sufficient savings from the reduced interest rate – making ARMs and discount points two divergent home-affordability strategies.