How Mortgage Points Affect You In Today’s Market
In real estate, there’s a few terms that are commonly thrown around, such as: interest rates, fixed rate mortgage, down payments, closing costs, etc.
But one thing that you don’t hear very many people talking about or educating on are mortgage points.
Around here, you know that my motto is that educated people make smart moves and no matter how many Forbes articles you read or real estate podcasts you listen to, all the things happening in the market right now can be tricky and it can all start to blend together resulting in you taking no action at all.
To help you avoid putting your life on hold and risk missing out on massive opportunities that are right in front of you when it comes to real estate, I’m committed to doing the digging for us both and lay it out so that you can easily understand what’s what and feel confident in your next move.
A hot topic that has been circulating today's market (I’m writing this in November of 2022) are mortgage points and the reason being is because the way you can use (or are being forced to use, I should say 🙃) has changed quite a bit. So, let’s dive in ⬇️
The Basics of Mortgage Points
On the most basic level, mortgage points, also referred to as discount points, are essentially a form of prepaid interest that you can choose to pay up front in exchange for a lower interest rate and monthly payments. This is known as “buying down” your interest rate.
(note: this is different from the 2-1 buydown that I talked about a few weeks ago - you can see all the info for that secret weapon here!)
The available interest rate for any product has a price and/or rebate. In this instance, price equals the cost for the rate and that’s what is always described as points.
One mortgage point equals 1% of your total loan amount, so for example on a $400,000 loan, 1 mortgage point would be $4000.
As a buyer in a lower rate market (different from what we’re seeing right now), you can opt to utilize points to buy down your interest rate and that cost would be included in your total closing costs i.e. the money you bring to closing when you officially purchase the house. Think of this like “out of pocket costs”.
In exchange for each point you pay at closing, your mortgage annual percentage rate (APR) will be reduced, in turn reducing your monthly mortgage payment.
So essentially, mortgage points in a “normal” market are an optional method you can use to lower your interest rate and your monthly payments by paying a larger sum upfront at closing.
But when the market starts shifting and interest rates start rising, the way that lenders use mortgage points starts to shift as well…
How Mortgage Points Are Being Used In Today’s Market
When it comes to obtaining a loan, there is often a “PAR” rate, meaning the interest rate quoted to the borrower comes with no cost or rebate for the customer.
A PAR rate is the special mortgage interest rate that any given financial lender will charge you as the borrower for access to a specific loan product.
In times of low interest rates, investors can confidently expect that they will make money off of the interest on the loan as it will stay in place for a longer period of time, due to the low rate.
It’s for this reason that in times of low rates, you can fairly easily receive a loan product at the PAR rate or rebate pricing.
Additionally, in times of low rates you have the OPTION to buy mortgage points in order to lower your interest rate even further thus lowering your monthly payment.
But when interest rates start rising, investors expect for the life of the loan to be shorter due to the high interest rates, meaning they can’t expect to earn money off of the interest of your payments. As soon as the current interest rate starts to decline, that is when consumers like to refinance into lower payment, thus ending the life of the loan.
This is where we’re finding ourselves today because, simply put, Investors still have to get paid, so to combat this and make sure they still earn money, they look for ways that they can receive more money upfront…
And mortgage points are how they commonly do it.
In times of higher interest rates, it is very difficult and honestly almost impossible to obtain a loan with an interest rate at PAR (meaning no cost to you).
So, in order to get the rate as low as possible for you and ensure that they can still earn money, you’ll find that most investors will add on mortgage points as a non negotiable on your loan, causing higher upfront costs for you at closing.
To give you a better understanding of what this looks like in action, let’s dive into the possible loan options you may receive if you were seeking a $400,000 conventional loan.
Assuming you have good credit in the 720 range and you’ll be putting 5% down on the purchase price of $421,000 for a new primary residence:
7.125% rate = $0 cost to you - this is a PAR rate and in a more normalized market, you can expect to receive this option where there is no additional cost to you. Today, we aren’t seeing much of this. LET ME REPEAT: it’s very rare that you’ll see a $0 cost to you option in today’s market.
6.625% rate = 1 discount point - this is one of the most common options we’re seeing today where investors add 1 discount point resulting in an extra $4,000 added to your closing costs (out of pocket costs). In this instance, the interest rate is as low as it can go, but you have more cost upfront.
6.875% rate = 0.50 discount point - this is another common option where investors will offer only half of a mortgage point, which would equal an extra $2000 in this instance so that your upfront cost is a bit lower, but you would still see a higher interest rate.
I know what you might be thinking… that’s a whole lot of numbers and in all of the scenarios it appears that the cost is still high and that might make your stomach feel a little 🤢
“Kelley, aren’t you supposed to help me feel confident in buying right now?!?!”
Just hear me out, friend: what goes up ⬆️ must come down ⬇️
What I mean by that is that there’s absolutely no way that interest rates can stay where they’re at. In fact, the very act of investors using mortgage points in this way actually confirms everything we’ve been planning for: things WILL be changing!
They are anticipating the rate to decrease in a few short years, so they are planning accordingly.
It might sting right now, but it forecasts a GOOD thing and as I always like to say, the only way through is through, so view this like pulling off a bandaid - it’ll hurt at first, but it never lasts!
When interest rates start to lower, you will have that lovely option waiting for you in your back pocket known as ✨ refinancing ✨ which means you can finance your home again with a new loan at a lower interest rate, so that you aren’t stuck with high payments.
“But shouldn’t I just wait to buy until rates are lower?”
I get it, friend! It might seem like the smarter move is to just wait. But something I always tell my clients and my friends (ahem, that’s you!) is that there is almost always a cost to waiting - no matter what kind of market we’re in.
Acting now gets your foot in the door and opens windows for way more opportunities in the future. (also, would love some credit for the use of so many house puns, you’re welcome 💁🏼♀️)
Long story short: the way mortgage points affect your loan in the home buying process in today’s market is looking way different than what it looked like when interest rates were sitting at 5%. Even so, they shouldn’t scare you out of buying, especially if you feel the time is right for YOU!
Can you expect to pay a little more at closing in today’s market? Yes. Can you also expect to have options in the future once interest rates lower? Also yes.
What you want to focus on when it comes to the here & now, is that the fact investors are using mortgage points in this way insinuates that interest rates are going to decrease – which also means that the 2-1 buydown method becomes less of a risk for you as a buyer.
Overall, real estate is personal and when you know the ins and outs of all of your options, that’s when you can really win. 🏆
If you’re ready to walk through what this process would look like for you specifically, I’m here to help!
