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The best way to decide whether you should pay points or not
is to perform a break-even analysis. This is done as follows:
1. Calculate the cost of the points. Example: 2 points on a
$100,000 loan is $2,000.
2. Calculate the monthly savings on the loan as a result of
obtaining a lower interest rate.
Example: $50 per month
3. Divide the cost of the points by the monthly savings to
come up with the number of months to break even. In the
above example, this number is 40 months. If you plan to
keep the house for longer than the break-even number of
months, then it makes sense to pay points; otherwise it
does not.
4. The above calculation does not take into account the tax
advantages of points. When you are buying a house the
points you pay are tax-deductible, so you realize some
savings immediately. On the other hand, when you get a
lower payment, your tax deduction reduces! This makes it a
little difficult to calculate the break-even time taking
taxes into account. In the case of a purchase, taxes
definitely reduce the break-even time. However, in the
case of a refinance, the points are NOT tax-deductible,
but have to be amortized over the life of the loan. This
results in few tax benefits or none at all, so there is
little or no effect on the time to break even.
If none of the above makes sense, use this simple rule of
thumb: If you plan to stay in the house for less than 3 years,
do not pay points. If you plan to stay in the house for more
than 5 years, pay 1 to 2 points. If you plan to stay in the
house for between 3 and 5 years, it does not make a
significant difference whether you pay points or not!
Whatever happened to the conventional wisdom of waiting
for the rates to drop 2% before refinancing?
You have a 30-year fixed loan at
6.5%. A loan officer calls
you up and says they can refinance you to a rate of 6.0% with
no points and no fees whatsoever.
What a dream come true! No appraisal fees, no title fees
and not even any junk fees! Is this a deal too good to pass
up? How can a bank and broker do this? Doesn't someone have to
pay? Whose money is being used to pay these closing costs?
No––this is not a scam. Thousands of homeowners have
refinanced using a zero-point/zero-fee loan. Some refinanced
multiple times, riding rates all the way down the curve in
1999, 2000 and, more recently, in 2002. Some homeowners used
zero-point/zero-fee adjustable loans to refinance and get a
new teaser rate every year.
The way this works is based on rebate pricing, sometimes
also known as yield-spread pricing, and sometimes known as a
service-release premium. The basic idea is that you pay a
higher rate in exchange for cash up front, which is then used
to pay the closing costs. You will pay a higher monthly
payment––so the money is really coming from future
payments that you will make.
You can also think of this as negative points!
For example,
a 30-year fixed loan may be available at a retail price of:
6.0% with 2 points or
6.25% with 1 point or
6.5% with 0 points or
6.75% with -1 point or
7% with -2 points
On a $200,000 loan, the loan officer can offer you
5.75%
with a cost of -1 point, which is a $2,000 credit towards your
closing costs. A mortgage broker can use rebate pricing to pay
for your closing costs and keep the balance of the rebate as
profit.
Zero-Point Loans / Zero-Fee Loans
What are the benefits of a zero-point/zero-fee loan?
The main benefit is that you have no out-of-pocket costs.
As a result, if the rates drop in the future, you could
refinance again even for a small drop in rates. So if you
refinanced on the zero-point/zero-fee loan to get a rate of 6.75% and if the rates drop 1/2%, you can refinance again to
6.25%. On the other hand, if you refinanced by paying 1 point
and got a rate of 6.25%, it may not make sense to refinance
again. Now, if the rates drop another 1/2%, a
zero-point/zero-fee loan can drop your rate to 5.75%, whereas
if you paid points, you may have to do a break-even analysis
to decide if refinancing will save you money.
The zero-point/zero-fee loan eliminates the need to do a
break-even analysis since there is no up-front expense that
needs to be recovered. It also is a great way to take
advantage of falling rates.
Some consumers have used zero-point/zero-fee loans on
adjustable loans to refinance their adjustable mortgage every
year and pay a very low teaser rate.
What are the disadvantages of a zero-point/zero-fee loan?
The main disadvantage is that you are paying a higher rate
than you would be paying if you had paid points and closing
costs. If you keep the loan for long enough, you will pay
more––since you have higher mortgage payments. In the
scenario where you plan to stay in the house for more than 5
years, and if rates never drop for you to refinance, you could
wind up paying more money. If, on the other hand, you plan to
stay at a property for just 2-3 years, there really is no
disadvantage of a zero-point/zero-fee loan.
Whose money is it?
Since you are being paid "cash" up-front in
exchange for a higher rate, it really is your own money that
will be paid in the future through higher payments. Investors
who fund these loans hope that you will keep the loans for
long enough to recoup their up-front investment. If you
refinance the loans early, both the servicer and the investor
could lose money.
To summarize, zero-point/zero-fee loans in many cases are
good deals. Make sure, however, that the lender pays for your
closing costs from rebate points and NOT by increasing your
loan amount. So if your old loan amount was $150,000, your new
loan amount should also be $150,000. You may have to come up
with some money at closing for recurring costs (taxes,
insurance, and interest), but you would have to pay for these
whether you refinanced or not.
Zero-point/zero-fee loans are especially attractive when
rates are declining or when you plan to sell your house in
less than 2-3 years.
Zero-point/zero-fee loans may not be around forever.
Lenders have discussed adding a pre-payment penalty to such
loans, however few lenders have taken steps to implement such
a measure.
If you have questions just ask! You may contact
Virginia Mortgage Bankers, LLC
for your
mortgage questions by email, phone or by appointment in our
office.
Start now by filling out our secure application for
mortgage loans! Call us at
804.282.8808, Monday through Friday from 9 a.m. to 5 p.m. Eastern time
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