Hot Topic: To pay or not to pay (points), that is the question?

[Clayton Silva]

I recently had a bit of a shift in my perspective on advising clients to pay points recently and here are my current thoughts.  Feel free to disagree.  As a lender, I look at rate sheets and loan estimates literally all day long and for the longest time when rates were stable or declining it made little to no sense to pay points.  I kept that mindset too long into the higher rate environment and have recently shifted my perspective especially on refinances and here is why:

1) To frame this, it is important to first consider the total cost of refinancing.  After paying closing costs, title fees, appraisal, origination, underwriting, processing, legal and other fees, the typical refinance costs about 1.75 - 2.5% of the loan amount just in closing costs (obviously before people yell at me, this varies drastically by state, but having done loans all over the country I find this to be a pretty accurate estimate).  

2) Keeping the average 2% cost in mind and the fact that people typically refinance when rates drop about .75% - 1% or more, I wanted to see if paying an extra point now when I was already paying all the closing costs to buy the rate down made sense. 1 point can get you between .5% - .625% off the rate depending on the days pricing and the coupon you are pricing.  With that in mind, I can effectively "refinance" now by paying 1 point and getting an additional .625% off my rate without paying an additional set of closing costs. (Say on the initial purchase if someone is buying right now).

3) I can lock in a guaranteed better rate now and enjoy the lower monthly payments now, and only pay maybe 1 or 1.5 points instead of 2-2.5 points later when I have to hope that rates come down again.

4) This also saves a lot of time which is an important consideration as some refinances can take 30 days and a lot of paperwork gathering and headache etc.

Again, my thoughts on this largely revolve around risk aversion.  Someone who is less risk averse may be willing to wait to see if rates drop more significantly and take the higher rate for now and refinance down the road but for the less risk averse, it's definitely a meaningful conversation and pretty easy to quantify by taking the cost and dividing it by the monthly payment savings to determine a "break even" period to see if that makes sense for the client.

Curious to hear others' thoughts on this.