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   ARTICLE   |   From Scotsman Guide Residential Edition   |   May 2017

Bring Back the Buy-Down

Paying points on a mortgage fell out of favor, but the tide is once again turning

r_2017-05_Rofer_spotPrior to the mortgage meltdown, “buying down” the interest rate — or paying points to refinance — was commonplace in the industry. Over the past decade, however, there has been a shift, with borrowers and mortgage originators becoming spoiled by the “no point, no fee” loan options made possible by the historically low interest rates following the Great Recession. 

Most of the advertising seen on television and heard on the radio has emphasized these “no cost” loans. This environment has unfortunately led to many borrowers believing that they should never pay points for a mortgage, and that it’s not in their best interest to do so. Many newer originator s in the industry also believe this, and even some veteran originators seem uncomfortable presenting mortgage options that include a higher cost structure than what they have become accustomed to in recent years. 

One could reasonably argue that there is now even a negative connotation or stigma associated with paying points on a mortgage. This needs to change. It’s time to bring back the interest rate buy-down.

Financial sense

Interest rates have spiked significantly since late last year. In addition, the strengthening economy, combined with inflation and the Federal Reserve’s forecast for multiple rate hikes in 2017, are all indicators that interest rates will continue to rise. This rising-rate environment is making it increasingly difficult for originators to provide “no point, no fee” rate and term refinances to borrowers that result in a net tangible benefit. 

An excellent way for originators to help borrowers achieve the additional monthly savings they are looking for is through the implementation of a rate buy-down — also referred to as paying discount points. For the right client, buy-down options can be a great alternative to the previously prevalent “no cost” loans.

Mortgage originators should not fear a presentation of refinance options that include points. Rather, they should embrace the utilization of points as an effective way to provide below-market interest rates and increased savings to their borrowers. Paying points makes financial sense in many situations, and loan originators should get comfortable explaining the benefits behind a buy-down strategy to borrowers.

Recaptured costs

One benefit of paying points is that they are generally tax deductible. Thus, the actual cost of paying points is less than what it appears to be on the surface, once taking into account the borrower’s reduced tax liability. Of course, borrowers should always be advised to speak with a tax professional regarding their specific circumstances and their ability to deduct such a cost.

Another benefit of securing a lower interest rate for a borrower is that it results in a lower mortgage payment and less interest paid over the life of the loan. For many borrowers, a lower monthly payment and increased cash flow can make a huge difference in their household budget. A lower interest rate also can result in tens of thousands of dollars in interest savings over the life of a loan.

Homeowners should be encouraged to make the most of their investment by using home appreciation to their advantage.

A simple calculation will allow clients to see how long it will take them to recapture the cost of the initial up-front investment of paying points. Let’s assume a borrower is looking at a mortgage of $400,000 that features a 30-year fixed rate with no points and an interest rate of 4.125 percent — resulting in a monthly payment of $1,938 (principal and interest). 

If the borrower pays 2 points (2 percent of the loan amount, or $8,000), the interest rate will drop to 3.75 percent and a monthly payment of $1,852 — which is a difference of $86 per month. If you divide the $8,000 cost of the points by $86, representing the per month savings, it will take the borrower 93 months, or slightly more than seven years, to recoup the cost of the points. 

By showing borrowers the math behind the buy-down strategy, they can begin to understand exactly how long it will take them to “break even” and begin saving. For a borrower who plans to stay in their home long term, a seven- to eight-year recoup time along with a decent monthly savings makes the buy-down option a great fit.

Appreciation assist

Discount points also can be financed into the loan as long as the borrower has sufficient equity, which is a big plus for those who want to avoid out-of-pocket costs or don’t have the liquid funds available. Moreover, many borrowers have experienced strong home-value appreciation in the last few years — gaining significant equity by merely owning their home. By financing points, they can essentially trade a small portion of that equity for a lower payment and increased cash flow.

In addition, future home-value appreciation will help borrowers quickly regain the equity used for the buy-down cost. The CoreLogic HPI Forecast projects that home prices nationally will increase by as much as 4.6 percent on a year-over-year basis from October 2016 to October 2017. Zillow predicts 22 percent home-value appreciation over the next five years.

If these forecasts hold true, borrowers who finance points will regain their traded equity in only a matter of months. Homeowners should be encouraged to make the most of their investment by using home appreciation to their advantage.

Let’s assume a borrower has a $400,000 mortgage and a current property value of $500,000. Let’s also assume that borrower finances 2 points into a new loan for a cost of $8,000. Using CoreLogic’s projection of 4.6 percent annual appreciation, the borrower’s property will appreciate $23,000 per year, or $1,916 per month.

This appreciation will offset the $8,000 buy-down cost in about four months while still allowing the borrower to reap the rewards of a lower rate and added monthly savings for the life of the loan. Even if the property’s value only appreciates 2 percent per year, the borrower would still offset the buy-down cost in less than 10 months.

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Borrowers and loan originators should consider the benefits of a buy-down when evaluating refinancing options. The days of rejecting points out of hand should no longer be tolerated. After all, the rising interest rate environment isn’t leaving mortgage professionals or their clients with much of a choice. Loan originators should educate themselves and become proficient in explaining the cost-benefit analysis of buy-down options to prospective borrowers. 


 


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