Home Radio Segments Real Estate Round-up Should You Pay Your Mortgage Points Up Front Or Not?

Should You Pay Your Mortgage Points Up Front Or Not?

Terry Story, Mortgage Points

With Terry Story, 28-year veteran Real Estate Agent with Coldwell Banker in Boca Raton, FL

This week we chat with real estate agent Terry Story about ways and means of getting the home price and mortgage rate that best fit your financial situation, as well as the bigger picture on interest rates and the housing market circa Q1 2017.  As usual, Terry brings her deep understanding of housing markets, home buying, home selling, and related topics to the table, founded on 28 years as a real estate agent with Coldwell Banker—and her conversations with Steve are always enlightening and helpful.  Today’s topics are especially relevant to home buyers.

As Mortgage Rates Go Up, Will Housing Prices Top Out or Fall?

By way of a quick survey of the housing market, Steve and Terry parlay about the direction of interest rates and their effect on house prices.  Mortgage rates went up about three-quarters of a percent in Q4 of 2016, an amount Terry describes as “up sharply.”  Historically speaking, however, rates in the neighborhood of 4%, like we have today, are still very low.  According to Terry, the effect of rate increases on home prices is an inverse one: as rates rise, prices come down.  The exact timing can be tricky because there are a number of factors at work like housing inventory (the number of homes on the market) and the expectation of rising rates, which for many buyers lends urgency to purchasing a home sooner rather than later.  For a certain time, rates and prices might rise together, as we’re seeing now to some extent.  Eventually, this phenomenon plays out as a kind of natural market force, however, and prices will drop to accommodate higher rates.  Were this not to happen, affordability—sometimes called the “housing burden”—would be strained to the degree that buyers would be priced out completely and lenders might become gun shy.

No Free Lunch: Mortgage Points, Closing Costs, and ARMs

Throughout their conversation this week, Terry and Steve make clear that when it comes to buying a home, there’s no such thing as a free lunch, even when you’re using smart tactics to get the right home and right mortgage.

One common technique to negotiate a better interest rate on a mortgage is through paying what are called mortgage points, or discount points.  These are simply a single percentage point of the home price (1% = 1 point).  This practice is known as “buying down the rate.”  How it works is that the buyer pays a percentage (a point or two, usually) of the home price upfront in cash on top of their down payment.  In exchange, they get a lower interest rate on the loan.  This benefits those who live in their home for a relatively long period, as the discounted interest starts to add up to more substantial savings over time.  There is a breakeven moment after a certain number of months where the added upfront points paid are offset by the lower interest rate.  After reaching breakeven, the buyer enjoys savings beyond what a buyer who bought no points would pay.  On a $200,000 mortgage, one point up front saves roughly $9000 over a 30-year loan, and two points equate to a more than $12,000 savings.  A points calculator or amortization tables of the two scenarios will put concrete numbers to the concept, so consider that essential if you’re contemplating paying point(s) or you’re just curious.   It’s important to remember that this option is not ideal for everyone, and, furthermore, this not a handout from lenders, who leverage benefits from this practice as well.

Another method for negotiating a better deal—or more accurately stated, a better fitting deal, because this technique does not end up discounting the overall price paid for the home—is asking the seller to pay your 3% closing fees up front.  If the seller agrees, what happens is that they pay the closing fees and the buyer keeps their cash that would otherwise have gone to the closing agent.  The kicker is that this deal is immediately reflected in a higher home price, an increase that exactly matches the value of the closing fees.  Sellers with lots of prospective buyers may balk at this arrangement, but once they understand that they will be paid back for the closing fees by the buyer’s mortgage lender, many go along with the deal.  Buyers get to hold onto their cash in the beginning but will end up repaying the amount of the fees plus interest over time.

Adjustable rate mortgages (ARMs) represent another way to manage monthly mortgage payments.  The attraction for home buyers is a low-interest rate for the first 5-10 years, followed by a considerably higher rate after that.  It’s an option that might work well for someone who plans to move out of the home before the rate reset.   While a riskier scenario, if a buyer is highly confident that their salary will increase enough before the higher rate kicks in, an ARM may be a good play.  The problem, as we saw after the housing market meltdown, comes when home prices decline and lenders pull back at the same time the ARM resets.

Steve emphasizes that the takeaway on all these tactics is that there is no free lunch and that they should be used prudently as tools to address problems in a temporary way, not as a means to simply buy a more expensive house.  It’s easy to fall into this trap, and it rarely ends well.  Terry agrees that it’s vital to keep some cash in the bank as a rainy-day fund.  Finding yourself “house poor”—having most of your money tied up in your mortgage, home equity loans, or expensive home improvements—can be quite dangerous.  Affordability over the longer haul should determine the amount of your home purchase.   Surveying mortgage rates now in January 2017 and reading forecasts of continuing increases in the Federal Funds rate ought not to cause excessive handwringing and panicked buying.  Rates are still historically low, and the Federal Reserve is still committed to lower than normal rates.  Terry believes these lessons and observations are timely ones for millennials, who have, of late, entered the first-time home buyer market in force.  Good professional guidance and patience are always the right approaches to buying a home.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: It’s time for Real Estate Roundup.  This is the time every single week we get together with noted real estate agent, Terry Story.  Terry is a 28-year veteran with Coldwell Banker located in Boca Raton, Florida.  Welcome back to the show, Terry.

Terry Story: Thanks for having me, Steve.

Steve Pomeranz: Hey, you know, we’ve seen mortgage rates rise.  There’s no doubt about that.  We also see that home sales, or home prices, seem to be continuing to rise.  Take us through that and tell us what happens if buyers start to get priced out of the market because of the higher expenses for mortgage rates and higher home prices.

Terry Story: Sure. Well, we know for a fact that the interest rates have risen up, actually sharply, since the election.  As a result, as the interest rates rise, there’s an inverse relationship at some point going to happen.  Interest rates rise; the home prices will start to decline.  We’re at the stage right now, Steve, where so many people have been trying to buy a house, they’ve been on the fence. There is and will still continue to be a low level of inventory; so, as a result, the buyers that have been on the fence are trying to secure something before the interest rates go higher.  We’re going to see an initial push of prices go up but, at some point …The way that they control this is by keep raising the interest rates, that will neutralize one another.

Steve Pomeranz: Yeah, so-

Terry Story: It’s also an indication of a healthy economy and a healthy market, as much as we don’t like seeing this—you know, like, “Ah!  I’m paying more.” At some point, the prices will stabilize and not rise any more.  For some people, you know as interest rates rise your cost to purchase a home, obviously, goes up.  There are ways you can counter it.  One thing you can do as a buyer is what they call buying down your fees, upfront fees.  For example, right now let’s say we’re at 4.32; if you pay one point, and a point is equal to 1%, if you pay one point, that will allow you to buy at a lower interest rate.  Cash is king.  Having some money aside that you can allocate towards that will also keep things in check for you.

Steve Pomeranz: Just let me stop you there for a second.  It’s important for everybody to understand that, whether you pay no points or one point, it’s all priced into the loan.  In this case, it’s priced into the interest rate of the loan.  If you’re paying zero points, you’re paying a higher interest rate than if you were to pay one point, you’re going to be paying a lower interest rate because the banks, the brokers, the market’s got to get what it’s got to get.  There’s just different ways to skin a cat, so to speak.  Now, what’s important here though is if you are going to be paying points, remember that the lower interest rate is going to offset that payment to some degree financially, so you can figure out the breakeven.  If you’re going to break even in a year or 18 months, where the decrease in the interest rate or the lower payment you’ll be paying on your mortgage offsets that higher upfront payment that you’re going to make.

Terry Story: That’s right.  We’ve had it really good.  I mean, we’re talking 4.3%.  These are still very low rates.  What we’re going to see, Steve, is the inventory is going to stay tight and making it still competitive as we saw in 2016.  I think, eventually, the home values are going to start to stabilize and not rise as much as they have been.

Steve Pomeranz: All right, so we’re talking about buyers having options.  Is that the only option a buyer has?  I mean, there are other kinds of loans besides 30-year fixed loans.

Terry Story: Oh, absolutely.  There are adjustable loans that one can do.  They’re called ARMs.  They have a low fixed rate for a few years.  It’s typically five to 10 years, and then they adjust to a higher rate.  Those types of loans are really good if you’re a buyer that knows that you’re only going to stay in the home five to 10 years.  You know you want to upgrade.  I find a lot of first-time homebuyers, they know this is a stepping stone.  They know that their salary is going to increase in the next several years.  These may be appropriate loans for them to consider taking out.

Steve Pomeranz: There is some risk to them because, again, when the loan resets, it’s going to reset to the current interest rate plus some margin.

Terry Story: That’s right.  We’re going to have to assume that the rates will continue to rise because everything is cyclical, and we’ve been down for so long, it’s going to rise for a while.

Steve Pomeranz: Okay. What’s another buyer’s options?

Terry Story: That’s a good question.  The thing you can do is always ask the seller to pay closing costs, which would free up some of your cash so that you can absorb higher borrowing costs-

Steve Pomeranz: So, part of the negotiation.  However, if you’re in a bidding war with other buyers, that’s going to be hard to do, a seller’s not going to be …

Terry Story: That’s right.  You can ask a seller to pay 3% of your closing costs, but, at the end of the day, what you’re really doing is financing that.  If you think about, if a house is worth, let’s say, $200,000, and you’re going to ask the seller to pay down your closing costs, and he won’t take anything less than $200,000, you’re going to have to jack that price to, say, $206,000.  You’re paying $206,000, but the seller is giving you $6,000, so that’s $6,000 that you don’t have to come out of your pocket to purchase that house.  Really, you’re just financing that extra $6,000.

Steve Pomeranz: Yeah, that’s going to be in the mortgage, right?

Terry Story: Correct.

Steve Pomeranz: You’re paying it over a number of years.  There’s no free lunch.

Terry Story: There’s no free lunch.

Steve Pomeranz: It’s just moving the shelves around.

Terry Story: That’s right.  It’s trying to make you feel good.

Steve Pomeranz: Well, no I think-

Terry Story: These strategies do help when you’re cash strapped.

Steve Pomeranz: No, yeah.  They give you some flexibility.  If you use them prudently, you use them wisely, and you’re a little smart about it, you can use them to your advantage.  What happens, what goes wrong, is that when you only using these things, and you’re buying more house than you can afford because you’re fooling around with the shelves trying to make things cheaper, cheaper, cheaper-

Terry Story: You need to keep money in the bank.

Steve Pomeranz: Yeah, it’s all going to catch up.

Terry Story: You have to save for a rainy day.  I’m speaking, really, towards the millennials because the millennials are starting to come out in droves.  A lot of them, now, are paying off …  They still have a lot of college debt, but this is a market that is wanting to move from renting to home ownership.  It represents about 32% of the total market, these first time home buyers.

Steve Pomeranz: That’s a lot.

Terry Story: It is.  This is a good thing.  We want to see the first-time homebuyers.  That’s how we start the cycle.

Steve Pomeranz: That’s right.  Again, if rates rise a little bit, don’t be afraid of that.  That’s what the market can bear.  We’ve had cycles where rates have been much, much, higher.  Also, with the idea that rates will go higher in the future, today’s somewhat higher rate may look really attractive two years from now.

Terry Story: That’s right.  That’s right.

Steve Pomeranz: Don’t make your decisions based-

Terry Story: The stock market’s going up, and we’re starting to see a little bit of return if you invest in savings and CDs or what have you.

Steve Pomeranz: Exactly.  Exactly.  My guest, as always, is Terry Story.  Terry’s a 28-year veteran with Coldwell Banker located in spectacularly sunny, beautiful weather, Boca Raton, Florida.  Thanks for joining us, Terry.

Terry Story: Thanks for having me, Steve.