What are points and do I have to pay them?

Question of the week: What are points and do I have to pay them?

Answer:  Before we answer what points are let’s answer if you have to pay them. No, you do not, but read on to see if it is better to pay points or not pay points.

This question has come up more frequently over the past year as we have more first-time buyers entering the market, or buyers who have not purchased a home in some time and either do not remember having points in their transaction, or they did not pay them.

Points are the upfront cost of a loan. One point is equal to one-percent of the loan amount. For a $500,000 mortgage, one point is $5,000, one and one-half points is $7,500. Points are paid at closing as part of the funds needed in escrow for your purchase to be complete.

Calling the cost points instead of percentage of loan is helpful to avoid confusing as the cost of repaying the loan is based on the interest rate.

To clarify, points are the upfront cost of a loan and the rate is the factor determining payment.

Points and rates have an inverse relationship, like a teeter-totter. The higher the points the lower the rate, the lower the points the higher the rate.

You are purchasing a new home and getting a $500,000 mortgage. You call to lock in your interest rate for 45 days your closing date in on August 25th*. Based on the points teeter-totter you may have the following options:

1.875 points for a rate of 2.5%

1.25 points for a rate of 2.625%

0.5 points for a rate of 2.75%

No points for a rate of 2.875%

As you can see the higher the rate the lower the points, and if you do not want to pay points you can avoid them by taking the highest rate shown.

“Thank you for the explanation, which of the options should we choose?”

There are several variables that may come into choosing the points-rate combination that is best for you. In some instances, we the decision may be based on if we need the lowest rate for qualifying, in others we may need the no point option as you are a bit tight on funds for closing. In most instances we do the math.

This chart shows the cost in points for each of the rates above and the monthly payment. The final column, “Months to recapture,” is dividing the difference between the no-point option payment and the payment for that point and interest rate option and dividing it into the cost in points. Example below chart.

Points/Rate Cost in Points Monthly PaymentMonths to recapture
1.875 / 2.50% $        9,375.00 $        1,976.0096
1.25 / 2.625% $        6,250.00 $        2,008.0095
0.5 / 2.75% $        2,500.00 $        2,041.0076
0 / 2.875% $                     –   $        2,074.00 

At a cost of 1.875 points for a rate of 2.5% the months to recapture is 96, or eight years. What does this mean. Here is the example I always give clients when explaining the recapture figure.

Leslie and I purchase the home next door to you. We close on the same day, at the same price, with the same loan amount. Leslie and I decided to purchase our home with a the zero-point option and the higher payment, you decided to purchase our home with the lowest rate and highest point option.

On the first Friday evening of every month we get together for a cocktail. We do what neighbors do, complain about the dog down the street that always barks, the new restaurant that has opened, what we are doing for the PTA fundraiser at the kids’ school.

Also every month when we get together, you put $98 into a coffee can, this is the amount you saved on your mortgage payment that month compared to the mortgage payment you would have had if you had also chosen the zero-point option with the higher rate.

After we have had 96 First-Friday-Of-The-Month cocktail gatherings you will have $9408. You will have saved a little bit more money over that time frame as we saved up front by not paying points. From that month on our home will “cost” more as our total of payments plus points as closing will be greater than yours by $98 each month.

As you can see by the chart, the recapture difference between the 2.5% rate and the 2.625% rate is only one-month, so for $32 per month in savings per month you only gain one-month in savings. To delve further into this cost-payment comparison, the actual difference between the 2.5% rate and cost and the 2.625% rate and cost is actually 98 months ($3125 upfront savings for $32 more per month).

At this pricing the lowest rate makes very little sense mathematically since it will take about 8-years to recoup your cost of the loan no matter which rate option you select.

Please note that the cost difference between different rates is changing every day, some days the difference between rates is compressed making the lower rates “cheaper,” other days the difference is higher making the higher rates more of a long-term value.

One other way to avoid paying points is to put in your offer to purchase that you would like a credit from the seller for closing costs, which can include the points and more. In the current market this option is not very viable due to the number of offers on most listings for the seller to choose from. However, when the market becomes more level between supply and demand, or tilts in the buyer’s favor, this option is a good one for buyers to save cash at closing on their purchase.

As you can see, there is no clear cut answer to whether to pay points, or how many points, or not. The decision is situational depending on your needs, the timing in the market, and most importantly what you feel most comfortable doing.

As I always tell my clients, I am not paying for your home, I am not making your mortgage payment and I am not sleeping there—you are, so you need to make the decision based on what you feel is best for you. I just provide the options and the math.

*Rate lock terms are typically price in 15-day increments, 15, 30, 45 and 60 days. Longer terms are also available but after 60 days the increments are in 30-day periods. The longer the rate lock the longer the rate lock period the higher to cost in terms of points.)

Have a question? Ask me!

Thirteen years, and twenty-nine years, that was the last time, respectively that month-to-month and year-to-year inflation has been as high as it was in June. Consumer prices were 0.9% higher in June than May, and 5.4% higher than in June 2020. The “core” rate (food and energy prices stripped from data) is 4.5% higher than last year, the biggest jump since 1992. Inflation almost always leads to higher interest rates and the numbers released this week certainly add to upward pressure on rates.

Pushing prices higher were used car prices, up 10.5% in June, accounting for about one-third of the total increase in prices. New car production is slowly increasing as more computer chips needed for auto makers are finding their way into factories; as more new cars are available in showrooms and lots used car prices will soften. Also pushing inflation is the price at the pump, gasoline is 45% higher in June 2021 than June 2020.

A bit of a change in tone from the Fed, as a result of the surprising data on inflation. Still calling the spike in prices over the past several months “transitory,” it appears that many members of the Federal Reserve feel there is a “risk” that inflation will be higher and longer than initially estimated. As the kids used to say, “ya think?”

In part due to inflation, but more the result of opening wallets, retail sales saw another large increase last month, up 0.6% from May and 18% from last June. Retail sales exceeded in June exceed pre-pandemic levels. Retail sales are based on dollar spent, so part of the increase is due to inflation, with many states still providing additional funds in unemployment compensation there is additional support for consumer spending. Adding to the pool of funds for consumers to spend is the federal child-tax credit checks that start hitting bank accounts this week.

Rates for Friday July 16, 2021: Rates started heading up later in the day last Friday and continued rising Monday and Tuesday of this week. A bit of a rally on Wednesday and early yesterday has resulted in another flat week. At some point the Fed will need to act on inflation instead of analyzing it, when that occurs, and it will likely not be announced beforehand, rates will start to move higher.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.625%  Flat

30 year high-balance conforming                   2.75%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

We did something unusual yesterday evening; we went to the movie theater. Unusual in that the last time we saw a movie in a theater was Christmas break 2019, where our tradition is to go to Scottsdale for a week and see several movies while we are there.

We saw “Black Widow,” and it was wonderful to see the action on a huge screen and have big sound…especially when something blow up or crashed unexpectedly causing me to jump a bit in my seat. The movie was pretty good, I am not a huge follower of the Marvel genre of movies, but it was easy to follow along without the backstory and the stunt driving in some of the scenes were terrific. Better than the story was enjoying a movie the way it was made to be enjoyed!

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog