Mortgage Q&A
Question:
Should I pay points? Does a zero-point/zero-fee loan really exist?
Answer:
The best way to decide whether you should pay points or not is to perform a break-even analysis. This is done as follows:Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000. Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Example: $50 per month. 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. The above calculation does not take into account the tax advantages of points. When you are buying a house the points you pay may be tax-deductible, so you realize some savings immediately (consult an accountant or tax attorney for advice). 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!Zero-Point/Zero-Fee LoansWhatever happened to the conventional wisdom of waiting for the rates to drop 2% before refinancing?You have a 30-year fixed loan at 8.5%. A loan officer calls you up and says they can refinance you to a rate of 8.0% 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 1992, 1993 and, more recently, in 1996. 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 : 8.0% with 2 points or 8.25% with 1 point or 8.5% with 0 points or 8.75% with -1 point or 9% with -2 points
