Many people are familiar with the words “points” or “discount” in the lending universe, and its corresponding stigma (read: “I don’t like to pay the bank fees”).
Before you write-off points (no pun intended – speak to your CPA to see if they are deductable!), remember this: you are paying the bank either way (higher fees or higher rate) – there is no free lunch.
Banks aren’t just “nice people”, and even the “non-profit” (credit union) entities, have to cover spread and overhead (read: their employees aren’t working for free).
The question should be: HOW should we pay the bank, based on our financial objectives?
That said, paying some form of points (depending on how long you intend to keep a loan / property) can sometimes be more beneficial than you think.
There are quite a few scenarios (especially in today’s market) where discount points not only make sense, but depending on the volatility in the market, might be the only option to get a spot on the board. So, let’s discuss two types of rate-buydown options, and how they can be utilized correctly.
Two buydown options:
- Standard Discount Points (long-term)
- 2-1 Rate Buydown (short-term)
With standard discount points you’re paying more interest at the time of close (in a fee), in exchange for less interest over the life of the loan (via lower interest rate). Very common to see these used on investment properties, second homes, or other loan programs that carry higher pricing adjustments (ie, lower FICO, higher loan to value, etc). The best use of these is when you can have a recapture period that is less than the length of time that you intend on keeping loan / house for (ex; you pay $4000 more at close to save $100 / mo with lower rate = 40 month recapture period, and you plan on staying in home for 5 years).
A 2-1 rate-buydown is a type of financing that lowers the interest rate on a mortgage for the first two years before it rises to the regular, permanent rate. The rate is typically two percentage points lower during the first year and one percentage point lower in the second year (ex, first year at 3.5%, second year at 4.5%, and 5.5% for third year and beyond). These are typically for scenarios when (higher) income or (lower) debt load are just beyond the horizon, and they are trying to get the lowest initial output (payment) for the first two years (ex; a doctor in their residency years).
The key to using these tools correctly is asking the right questions and knowing your financial objectives.
As with all-things lending, you know where to reach us when you’re ready to discuss.