Mortgage rates took a big leap after the presidential election and are continuing to move higher. Demand for homes is strong, but home prices are hitting new highs and affordability is weakening.
For the average buyer who was thinking about getting into a new home last summer, but didn't, the monthly payment on that same home is now considerably higher. There is, however, a way to lower it by buying down the rate.
"Buying your rate down, or 'paying points,' means you're paying an extra fee on top of standard loan fees like appraisal, underwriting and a credit report to get a lower rate," said Julian Hebron, executive vice president of sales and marketing at RPM Mortgage.
Of course that means you have to have more cash upfront. The math isn't as complicated as it seems. First, a "point" is 1 percent of the amount of your loan, so if you are taking out a $200,000 mortgage, 1 point would be $2,000. Lenders will lower your rate if you pay that point at closing, or, at the start of the loan.
"If you were getting a 30-year fixed loan of $325,000, you might get two options with and without points. Today the option with zero points might show the rate as 4.25 percent, and the option with 1 percent in points — equal to $3,250 — might show the rate as 4 percent," said Hebron. "Paying $3,250 at closing to lower your rate by .25 percent lowers your payment $42 per month, and lowers your interest cost $68 per month."
How do you know if you should buy down the mortgage? It's all about time — how long you expect to be in the home and have that same mortgage. What is the savings? Here comes more math — this time from Matt Weaver, vice president of sales at Finance of America Mortgage.
"We can calculate this figure by taking the dollar value of the buy down and dividing it by the monthly savings from the lower interest rate, then dividing that figure by 12 months. So as an example, let's say our prospective homebuyer will need to pay $2,000 in buy down to generate $30.00/month in savings. If we divide $2,000.00/$30.00, we would conclude it would take 66.7 months, or 5.5 years, to recoup the cost of the buy down — now you can ask yourself, 'Do I reasonably foresee myself staying in this home for at least 5.5 years?' in order to truly capture the return on your investment," explained Weaver.
Sounds simple, if you have the cash and the time, but buying down a mortgage, as with everything else in housing, carries some risk.
"As they say, 'A dollar in the present is worth more than a dollar in the future.' The risk with the uncertainty in length of ownership coupled with the possible need of that same cash for any unforeseen expenses poses a risk for homebuyers considering a buy down," said Weaver. "The buy-down strategy can be worthwhile with a longer-term view in mind, longer term being defined as seven years or greater."
The benefits can also vary lender to lender. Shopping for the best rate is always a good plan but even more important when you're looking to buy down.
"The break-even time on buying down varies from lender to lender and from rate to rate, generally in a range of five-10 years. Look at different combinations of rates and upfront costs side-by-side and see which makes the most sense for you," suggested Matthew Graham, chief operating officer of Mortgage News Daily. "Heads-up: Some lenders with stricter interpretations of recent regulatory changes no longer allow this flexibility."
If you really don't see yourself in the home for more than seven years, or even 10, you might want to consider an adjustable-rate mortgage (ARM). These carry much lower interest rates and can be fixed for five, seven, 10, even 15 years. They were vilified during the housing crash because so many people took them out and then couldn't afford the payments when they adjusted, but the ARMs of today are not those of years past. Read this for more on ARMs.
One more thing to consider is the rate itself. Mortgage rates are rising, but they are still near historic lows. If you are really on the edge of homeownership, perhaps you're a young first-time buyer, then buying down the rate is probably not for you. The odds are you're going to want to be more mobile, and staying in the home for seven years is longer than it sounds. Bailing out of the home before you expected is a real risk.
"The other risk of buying down your rate is that rates drop after you do so," cautioned Hebron. "For now that risk is low. The Mortgage Bankers Association is predicting that rates will rise about .375 percent from current levels during 2017."
While rates are expected to rise, the experts have been wrong before. Rates could just as easily come down and credit availability could loosen up, depending on how the new administration tackles mortgage reform. Rates are also sensitive to global financial markets, which are always a wild card, and especially so now.