Today is one of those days where it would be foolish and wild to venture over into ‘where rates are heading’ territory. They might be down big today, but in a day or two swing back up. So guess what? I’m not going to touch that stuff. What I want to tell you about is PAYING POINTS in the current market, and how that may make good sense in both purchase and refinance transactions.
I usually do not recommend paying points, especially on purchase transactions, because that is real money, out of your pocket that could be better utilized (nest egg, anyone?). You sell the house or refinance in five years, and that money is GONE and not coming back. However, in today’s current climate, it may make sense on BOTH purchase and refinance transactions to pay a point, or even two. Let me explain.
FHA and most conforming loans allow up to 6% in seller contributions- on a $200,000 loan, that totals $12,000. Up here in Connecticut, that will pay for all your closing costs, and leave you a nice chunk leftover. Let’s assume you can only negotiate a 4% contribution. Let’s then assume you use 2% for regular closing costs (attorney, title, etc.) That leaves you with 2%. Use that money to your advantage, and ‘buy’ the rate you want. If the current rate is 6%, and you can get to 5.5%, it is definitely money well spent. You’ll save $70/month in this example, and more importantly you’ll probably never have a need to refinance to ‘get a lower rate’. The interest savings will be fantastic over the term, but realistically no one stays with the same loan for 30 years. BUT, the likelihood of rates going back down, and enticing you to spend money on a refinance would be pretty slim if you obtained such favorable financing terms NOW.
When it comes to refinance transactions, most people roll their closing costs into the loan. The reason I like paying points right now on these transactions is simple- the closing costs are coming out of your equity, not your savings account. Hopefully, equity will begin to rise again, and the money spent on purchasing the lower interest rate will replenish itself. But, you have a lower interest rate, and therefore a lower monthly payment RIGHT AWAY. That is a tangible benefit to you. Also, like the purchase transaction above, the odds that you will want to refinance for a lower rate in the future are VERY SLIM.
I have known people that, during the refi boom, refinanced two or three times (not my clients, in the spirit of full disclosure), and wasted money on closing costs totaling well over $15,000. If they had taken some of that money up front and bought the rate they wanted, they would have saved time, money and probably sleep. “Chasing” the lowest rate is very common, and not a wise investment.
If you are purchasing soon, have your real estate agent discuss what your options are. In some areas, it is not uncommon to see 6% seller contributions, in others it is absolutely unheard of. The key is negotiating, and using the earned dollar power to your full advantage. Your loan officer should also be able to explain the benefits of paying points, as well as what each point will do for your bottom line.
If you are refinancing, realize that rates will probably not be this low, or lower, again anytime soon. Things have happened in the financial markets that have sent rates on a tailspin, and that will eventually correct itself. I don’t know what will happen with the rates in the coming years, but I do know that if you get the financing terms you WANT or NEED now, the likelihood of wanting to “chase the rate” is extremely low.
Paying points last year, when rates were at 6.5% or so, would prove to be foolish. People who did so will undoubtedly want today’s lower rates, and refinance. It’s not hard to see how that happens, but that’s real money out the window- OUCH! To sum up, I would say ‘Pay points when rates are low. Don’t pay points when rates are high’. You’ll save heaps of money just following that one piece of advice, IMO.
Have a great day, and be sure to check out my deal-making, money-saving tips- on this blog- weekly!
Jennifer Monastero
Citizens Community Bank
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Comments
18 Comments so far
Don Fabrizio-Garcia
Good points. Pun intended.
In the past, we’ve always been anti-point-paying. Paying them now does make sense. Something for all buyers and refinancers to consider.
Dan Melson
Paying points by adding to your loan balance is just as costly as money out of your savings account. Indeed, you’re paying interest on it in your balance, versus not receiving interest for it in your savings account. It may be situationally dependent as to which makes more sense - assuming it does make sense - but it’s the same number of dollars.
Today’s rates are decent for loans with some decent equity, but I’m starting to think that rather than rates in general rising, we’re more likely to see a significantly greater cost differential for low equity situations. Rates are going to go up and down, of course, but I’d look for them to hit today’s rates again in the not too distant future.
Jennifer Monastero
Dan- I disagree with your first thought. Money in a savings account is tangible and liquid. Money in your home’s equity is really neither. Yes, you are paying for an extra $4000 (for argument’s sake) in loan dollars, but the monthly savings, and future savings in not having to refi, is much more substantial and real. Not on paper, but real dollars in your pocket.
Dan Melson
Jennifer,
You can disagree with the thought (about how funding loan costs with equity is no different than funding them out of your savings account) all you want. In both an economics sense and an accounting sense, you are wrong. In fact, in terms of one financial statement, the Statement of Cash Flows, it’s objectively worse.
It’s also usually worse on the Income Statement. It can only be better if you actually use the cash for an alternative investment with a higher rate of return than the mortgage. The average borrower does not.
There are reasons to pay for loan costs via equity. Far more often, however, it’s greedy loan officers who won’t explain to their clients that a dollar spent is, at the bottom line, still a dollar spent, and a dollar saved is still a dollar saved. There may be reasons why you are better off for having spent that dollar, but the bottom line is that it’s still spent. Most consumers think in terms of cash flow, and don’t understand dollars paid for with equity are the same dollars as dollars paid for from their savings. It’s an emotional difference, but not a economic, accounting, or mathematical difference. If you shouldn’t spend one, then you shouldn’t spend the other. End of discussion. End of topic. You can try and refute this all you want - but I and many others can prove it mathematically, and show mathematical flaws in any model that purports to show anything else.
If you want to do the right thing by consumers, you need not only to understand this, you need to be able to explain it to consumers that do not understand.
Dan Melson
I am going to let the personal slide.
This isn’t personal. It doesn’t have to do with who I am or who you are - it has to do with facts. Mathematical facts, accounting facts, economic facts. It isn’t a matter of opinion. Opinion you can shade. Facts are facts, and exist independent of the observer. They can be wrong, but once the correct answer is known, they are facts.
If I count the number of seatbelts in my car, there are five. That’s a fact, externally verifiable by someone going over and checking my count. Someone claiming there are four can be shown the fifth belt, someone claiming there are six can be shown to have counted one twice.
This situation is a little more complex than that, but facts they remain. Some people don’t like to delve far enough into the question to obtain the answer that they are facts; nonetheless they are.
You can dislike it all you want. You can take shelter in umbrage at someone who points out that you are factually incorrect. That doesn’t change the fact itself, and this is a fact that way too many loan officers pretend doesn’t exist. A dollar out of your pocket is the same dollar if pulled from your equity, and as a matter of fact, a full accounting of the situation usually shows the dollar out of equity to be marginally more costly. If you cannot justify a client paying the money out of pocket, you certainly cannot justify paying it via equity. Fact.
If you want to argue it, fine. That is the way new discoveries are made. But confront the math and the accounting and the economics directly, and keep it to a direct comparison of merits and demerits. Don’t give me vague garbage about “but the monthly savings, and future savings in not having to refi, is much more substantial and real. Not on paper, but real dollars in your pocket.” That’s playing hide the salami, because if the benefits exist, they are just as real with greenbacks counted off of a roll of cash in the client’s pocket. That money in the loan balance is every bit as real as dollars in pocket. Fact.
Brian Brady
One factor that favors Jennifer’s proposition is that you may not be able to finance those loan costs in the future. Cash left in the bank trups cash that you may never access (falling values, falling LTVs, etc)
Dan is correct when he points out that mathematically, financed loan costs are more expensive than costs paid in cash (just compare the after-tax savings account return vs, the after-tax cost of money).
Dan, while I agree with your factually correct math, in your opinion, isn’t the “negative arbitrage” worth the security of that extra cash in the bank?
Jennifer Monastero
Dan, I’m not exactly sure why you feel the need to get so abrasive. If you take issue with one or two points in the blog, try addressing them in a more succinct, consumer-friendly manner. I hardly think consumers care much what a fictional ‘mathematical model’ says. We’re talking about dollars and cents that matter. If your issue is with rolling closing costs into a refinance transaction, please state that. If your concern is that someone will be losing equity to gain a little cash flow each month, please tell that to someone who has seen their home value plummet by 15% in the last two years. Equity is paper, it is not tangible, and no mathematical model could possibly tell what one’s equity will be from one year to the next. One can, without a doubt, tell what one’s mortgage payment will be at rate X and rate XX. What matters is which one is more attractive NOW.
Brian, I absolutely agree that financing $4000 (again, for arguments sake) means that $4000 is stretched over 30 years, and turned into much more than that. But the benefits to the current situation are what matters. If it saves a person $200/month, but costs them $8000 in equity, aren’t they better off with that extra cash flow? I guess I am lost on Dan’s point, mostly because he is very abrasive and hard to follow. But I agree with you- cash in the bank DOES trump equity, and cash out of SOMEONE ELSE’S (seller’s) bank trumps all!
Brian Brady
Actually, Dan is very precise, as we all should be. His personality (or mine) is immaterial when discussing facts. Factually, he’s completely correct.
“But the benefits to the current situation are what matters. If it saves a person $200/month, but costs them $8000 in equity, aren’t they better off with that extra cash flow?”
I think you might be missing the point, Jennifer. It IS worth $8,000 to save $200; that’s undisputed. The issue is whether or not it’s worth financing that $8,000, by adding it to the loan balance.
I believe that the net, after-tax cost of funds, to “finance” that $8,000, by adding it to the loan rather than taking it from the bank account, is only about $12-$15/month. It is my opinion, in this market, that the 12-15 bucks is worth it. I’m interested in Dan’s opinion.
(Dan, if my math is wrong, correct me. It wouldn’t be the first time you’ve done that, which I appreciate)
Jennifer Monastero
Brian, I do believe I got that point, which is why I said what I said. I could be totally off base here, but I don’t think consumers want to trouble themselves with mathematical models, ‘Income Statements’, and ‘Statement of Cash Flows’- what are those? I have no idea, so I don’t expect consumers to know. Not everyone has an MBA, nor should we.
When it comes to my original post, I think I am pretty clear- if a buyer can get a seller to pay closing costs, the best use of some of that money is to buy the rate down. This will, by anyone’s accounts, help them NOW, and in the future.
When it comes to refinancing, if they plan on staying in the home (or maybe even not) paying points would make sense if the tangible benefits are there NOW. We can argue semantics all day long about what the additional interest is, or how much equity will be lost, but that just isn’t real to most people.
It seems to me that when Dan says that I am wrong, he means on all counts, in all instances. I take issue with that. ‘Factually, he is completely correct’. How? How are his assumptions correct?
Please, display this ‘model’ you speak of. Input data from a typical refinance transaction (since that seems to be where we are having our squabble). I’d love to see what it is all about.
Brian Brady
“I could be totally off base here, but I don’t think consumers want to trouble themselves with mathematical models, ‘Income Statements’, and ‘Statement of Cash Flows’- what are those? I have no idea, so I don’t expect consumers to know”
Mortgages ARE math, Jennifer. I won’t presume to answer for “consumers” as a whole but specifically, my customers expect me to command the math associated with home finance; a level far below a MBA.
“Please, display this ‘model’ you speak of.”
I don’t understand. I’m not referring to a model, I’m referring to the opportunity cost of funds. Let me try and define that for you.
Should you take the points ($8,000) from your savings account, where it will could you $240/year in interest or should you increase the loan, where that $8,000 would cost you $480/year in interest but allow you to make the $240 in interest in the savings account?
It “costs” then, a net $240/year to borrow that extra $8,000. Knock off a third for the tax savings and we get to $180, or about $15/month.
Those are the mathematical facts associated with this case study. It is my opinion, in this tight credit environment (which I expect to get worse), that $15/month, after-tax, is worth it. If I thought rates were going lower and credit would be more readily available, in the next 3-5 years, my opinion would be the opposite.
ali burton
I am confused. Isn’t the point Jennifer’s trying to drive home that buying down the rate could come out of the seller’s pocket? If that gets negotiated why wouldn’t a buyer try to buy down the rate?
“I think you might be missing the point, Jennifer. It IS worth $8,000 to save $200; that’s undisputed. The issue is whether or not it’s worth financing that $8,000, by adding it to the loan balance.I believe that the net, after-tax cost of funds, to “finance” that $8,000, by adding it to the loan rather than taking it from the bank account, is only about $12-$15/month. It is my opinion, in this market, that the 12-15 bucks is worth it. I’m interested in Dan’s opinion.”
Now I’m really confused. I think Brian proved himself wrong simply because that $8,000 will in fact not make much of a difference in mortgage payments- meaning you are in fact better off trying to get a lower rate, even if that means you won’t have as much equity. To most people having more money every month and more money in the bank, especially if they can have someone else pay closing costs, is a little more desirable than having a whole $8,000 more in equity/money they can only touch when they sell or refinance their house.
Jennifer Monastero
“Mortgages ARE math, Jennifer. I won’t presume to answer for “consumers” as a whole but specifically, my customers expect me to command the math associated with home finance; a level far below a MBA.”
Brian, my comment was for both you and Dan. What is an ‘Income Statement’? What is a ‘Statement of Cash Flows’? What is the model that Dan and others would use to disprove my theory that paying points, right now, may actually make sense for plenty of people?
We agree on your costs of funds illustration, I am not disputing that adding to a mortgage balance draws out the term, therefore ‘costing’ the consumer more in the long run. You need not explain that tidbit to me. But could you please add in the interest savings, so that there is a ‘net savings’ per month, instead of just a net cost? It seems like you left out a very important piece there.
Also, when it comes to something like transportation, I can’t imagine you OR Dan recommending that someone ever purchase a vehicle. It is a depreciating asset, and one that will cost the consumer far more money in interest and up keep, not to mention gas! Glad to hear you are of the mind where riding a bike to work is the only way to go. According to my mathematical model, car ownership is a BAD choice in any possible instance. Spread the word. (sarcasm there, just so you know)
Ali, very true, but Brian does make a good point about the actual costs of ‘rolling’ closing costs into a loan. It does stretch out that money over a longer term, and you end up paying back a heck of a lot more. But, I have yet to meet someone that stuck with a 30 year mortgage until the end- so really, I still agree with myself (haha), if the benefits are real, and in the NOW, paying a point or two should absolutely be considered.
Brian Brady
Okay. Question for both ladies:
If you increase someone’s mortgage balance by 8,000, is that $8,000 borrowed?
Jennifer Monastero
Brian, yes. Again, I am not arguing with you on this point. To me, it’s semantics. If your point is merely that the $8000, when stretched, becomes $10,000, then say that. When you start talking about something that only exists on paper (equity), then it goes into the gray ‘who cares’? zone. Here one minute, gone the next. So, which bothers you- the loss of equity, or the cost of the funds?
I would however like to know what a ‘Statement of Cash Flows’ is. Any clue? Dan seems disinterested now.
Brian Brady
“So, which bothers you- the loss of equity, or the cost of the funds”
Neither bothers me, but this statement does:
“When you start talking about something that only exists on paper (equity), then it goes into the gray ‘who cares’? zone”
A loan has to be repaid. If you increase the loan amount, you’re borrowing it. I always care about my cost of funds, Jennifer.
“I would however like to know what a ‘Statement of Cash Flows’ is. Any clue?”
A cash flow statement measures the flow of cash in a business, including but not limited to the cost of and return on capital. A banking concern would call this the sources and uses of funds statement. An individual’s cash flow statement would be useful when analyzing whether or not that $8,000 expense should come from cash or a loan.
Does that help?
Jennifer Monastero
Brian- I know what a ‘cash flow statement’ is, but had never thought it had to do with anything other than a business. Nor had I ever heard it referred to as a ‘Statement of Cash Flows’.
“A loan has to be repaid. If you increase the loan amount, you’re borrowing it. I always care about my cost of funds, Jennifer.”- so, you concern yourself with the cost of funds- correct me if I am wrong, but that has little to nothing to do with equity. Equity IS a gray zone, and one that cannot possibly be determined by a ‘model’. Someone may have $25,000 in equity today, and absolutely NONE in two weeks. So, to utilize it while they DO have it actually makes even more sense.
I still can’t figure out what you are arguing about.
Brian Brady
Forget the equity argument, Jennifer- it really is immaterial when analyzing the “cost” of the funds to obtain the loan rate.
The fact is that those points aren’t “free”, equity or no equity.
Now, the AVAILABILITY of equity comes into play when analyzing cash positions. Financing points, while a losing proposition financially, becomes more attractive regardless of that losing proposition in an environment of potentially shrinking equity.
The costs discussion is merely a statement of fact. The conclusion, after analyzing the future availability of those funds, is a matter of opinion. I agree with your conclusion that the availability of those funds today trumps the cost of those funds, today.
Jennifer Monastero
Thanks Brian. Like I said, I think we actually agree.
Perhaps I could have been more ’scientific’ in my approach in the original blog, but I really don’t find that jives with consumers all that well.