We asked Nicole Rueth, with the Rueth Team at Fairway Independent Mortgage Corp. in Englewood, Colo., for tips about how borrowers can make the decision about when it makes sense to pay points for the loan.
“The median years of home buyers staying in their homes is now 13 years compared to just eight years in 2010, according to a study by Redfin,” Rueth wrote in an email. “As more buyers live in their homes longer, they will need to consider the advantages and disadvantages to paying extra to lower the mortgage rate, increasing their mortgage payment amount, or saving and investing elsewhere.”
Rueth wrote that paying for a lower interest rate isn’t always automatically the best option.
“Ultimately, you will pay the costs; it’s just a matter of now or later, and how long you plan on living in your home,” she wrote.
Three options for cash when buying a home:
Rueth analyzed the choices for a borrower with an extra $2,000 to spend when they’re buying a home:
1. Paying points: Paying $2,000 to buy down the rate using points from today’s 3.875 percent to 3.75 percent results in a monthly mortgage payment savings of $28 per month. Dividing the savings into the cost yields a payback of six years, which means it would take six years to make that $2,000 back. After six years, the lower interest rate saves $28 per month — possibly more if the borrower pays extra on their payments since a mortgage is a simple interest loan.
2. Making a bigger down payment: Alternatively, if the $2,000 were applied toward the down payment, a lower loan amount would result in reducing the monthly payment by $9 a month. If a home buyer has a high degree of confidence they will not reside in the home longer than the break even point for buying down the rate, applying the $2,000 toward the down payment has a small monthly benefit while increasing the immediate equity in the home. Note that this reduction in principal adds up to a savings of $375 in interest paid in five years.
3. Investing the cash: Another consideration is to apply the same $2,000 into an alternative investment opportunity that provides a return higher than 3.875 percent, regardless of how long you intend on staying in the home. The funds could be set aside and earmarked for the next real estate investment or invested immediately in alternative opportunities. Despite inherent risk to investing, given today’s low mortgage rates, there are multiple options that could yield more than 3.875 percent. This is especially the case when investing in residential real estate where you can add up appreciation, principal reduction and tax benefits.
“Paying points can be most advantageous to homeowners who plan on living in their home more than four to six years or those who plan to turn their primary home into a rental investment in the future,” Rueth wrote. “What I typically see is that first-time homeowners do not live in their homes long enough to see significant advantages to pay points, as it may not save them money in the long run.”
Working directly with a mortgage professional who knows your goals and personal situation is important to ensure your strategy is aligned with the right choice.