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With Home Loan Market in Flux, Paying Points Is Golden For Many
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· Interest-only, 30-year, fixed-rate loans: Until recently, the 30-year, fixed-rate mortgage that allows interest-only payments for the first 10 years was very popular. Borrowers could avoid making payments to principal for 10 years. To get the interest-only option, borrowers typically paid a rate premium of about 1/8 percentage points.
No more. In an environment of declining home prices, investors don't like loans that build no equity for 10 years, and they have raised the premium to about 1.4 to 2 percentage points.
To illustrate, one lender priced a standard 30-year, fixed-rate loan for $400,000 at 5.75 percent and the interest-only version of the same mortgage at 7.25 percent. This means that the borrower was offered a choice between paying $2,354 a month, of which $1,917 is interest and $437 is principal, or paying $2,416 a month, all of which is interest. This pricing eliminates the only benefit borrowers receive from an interest-only loan, which is the lower payment.
Bottom line: Borrowers should avoid the interest-only option on the 30-year, fixed-rate mortgage. On ARMs, however, the rate premium to get an interest-only option is still reasonable.
· Paying points to reduce the interest rate: Stressed markets do offer one significant bargain: buying down the interest rate by paying points. In 2005, it cost about 1.5 points to buy down the rate by 0.25 percentage points on a 30-year, fixed-rate loan. (A point is 1 percent of the mortgage.) In early 2007, it cost about 1.125 points. Today, the price is down to about half a point.
In part, the lowered price is due to the shorter average life of loans, which increases the value to investors of collecting points upfront. In addition, lower rates carry lower payments, which reduce the likelihood of default. In a stressed market, this carries a lot of weight.
Borrowers viewing a rate buy-down as an investment can earn a very high return. For example, one lender on Dec. 12 offered a rate reduction of 0.5 percentage points for 1.119 additional points. This investment in points would yield 28 percent over five years and 32 percent over 30 years.
Bottom line: Buying down the interest rate is a very good investment.
Next Saturday: Some tips on shopping for the best deal in a stressed market.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http:/
© 2009, Jack Guttentag
Distributed by Inman News Features
