Are points on a mortgage worth it?

Question

Chris Mason · Answer

This is spot on math, and need not be further complicated for owner occupied real estate.

For investment properties, there's opportunity cost to consider. Basically a question to ask: Is there something else I could do with that $2250 that would allow you to increase cashflow/rents by ~$50 per month or more? This is a property specific question, as the answer will involve further questions like: what does the kitchen look like? What do the bathrooms look like? Etc.

$42/mo for $2250 has a CoC ROI of about 22%. If you aren't short on funds, the answer might just be to do both things -- buy the rate down for $42/mo of improved cashflow, AND do the kitchen upgrade that will allow it to command $50/mo more in rent. Eventually you will come up against diminishing returns (replacing two year old non-stained carpets, for example, probably isn't worth it), but these little >20% CoC ROI things add up. If it's a turnkey property that already has the brushed aluminum oven, fancy new fridge, etc etc, then it's more likely that the rate buydown will be among the more solid possibilities.

Bruce W. · Answer

You can get a cheap financial calculator or download an app to do the mortgage calculations needed to answer this question. I did the math and here's what I found:

mortgage amount = 112500

monthly PI payment at 4.5% = 570.02

monthly PI payment at 3.85% = 527.41

difference is $42.61 per month.

Dividing your points amount ($2250) by the difference yields just under 53 months.

If you keep the mortgage for 53 months or more, paying points will save you money.

There may also be some taxation concerns considering the deductibility of points, but I don't have that info.

Chris Mason · Answer

Nah, that adds up. Ballpark 0.3 to 0.7 discount points per 0.125% to rate is about what I typically see for FNMA direct stuff from most lenders. Some days the buy-down is more appealing than other days, and eventually you get into diminishing returns. So it might have been 0.3 to go from 4.5% to 4.375%, but another 0.7 to go from 4% to 3.875%, and perhaps it jumps up to 1 full point to go from 3.875% to 3.75%, which might be why that option wasn't presented.

I will not post the rates for compliance reasons, but I picked an arbitrary lender and the buy-downs are below. Each increment is 1/8 to rate. I'm going to put letters instead of rates, with A being the highest rate and G being the lowest.

A: -0.005

B: 0.110

C: 0.610

D: 0.943

E: 1.426

F: 1.943

G: 2.874

Obviously "no points," which is A%, makes no since due to it being so cheap to go to B% - break-even will be a few months. And B% to C% is 0.5 but it's only another 0.3 to go to D%, so if you're going for C% you might as well take it to D%. And then from F% to G% is obviously in the severe diminishing returns range. So I might present B%, D%, and F% as the three options. Or present them all but highlight B%, D%, and F% being the three that make the most sense.

If curious for the logic, it's based on what Wall Street is doing. Maybe there are statistical models that predict C% loans getting paid off in full & sooner more frequently than D%, so Wall Street pays a premium for mortgage  backed securities with more of D% in it, which is passed onto the consumer in the form of D% being offered for merely 0.3 more than C%.

Chris Paez · Answer

@Chris Mason I just love feeling stuck on something and coming on here and getting such valuable info. I'm about to refi a rental property and I was wondering if paying points would be worth it to me. After reading this I'm still not sure, but I will make a better more educated decision now. Thank you for the valuable points you made.

my situation is something like this:

-I can pay $7,000 in points and free up $115 in cash flow.

-This is the last refi I'm planning on this property and I will be getting cash out. (thats probably what everyone says!)

-I like the idea of getting a better DTI ratio for my next purchase but I'm self employed so I could technically take less write offs and claim more to achieve the same DTI for a smaller one time payment in taxes.

Laying it out right now makes me think keeping the cash instead of paying points would probably make most sense...

Thank you for putting it out there! @Michael Eng

Matt K. · Answer

What's your long term plan? P&I @ 4.5% 475 vs 440 @ 3.85%. If it was me I'd rather toss the 3k towards reserves vs 35 mo savings. Plus you'd need to keep the house like what 87 mo's before you break even on the points.... something will break before then and you'd much rather have the liquid 3k.

Chris Paez · Answer

gotcha! thanks man!

Chris Mason · Answer

No, I'm saying that the rate being this way or that by 0.5% very very rarely is make or break. As a self employed person, that last single sale you make in late December of this year will move the needle more. Getting $30k off the sales price of the next home you buy will also move the needle more. Buying a car you can afford instead of one with a payment will move the needle WAY more. Etc, etc.

Interest rate is certainly important for your personal finance reasons, but not really that important for getting that next mortgage compared to everything else. It's not 2005 where a week changes your rate by 2%.

Chris Paez · Answer

Well I thought it would have an impact on how I look on paper for the future. But In the same vein the property would look better on paper as well. I'm always attempting to get loans that are %5 down and Im calculating my tax returns to hit just the right numbers for the purchases, so I guess I am always feeling like my DTI could make or break my loans. Are you saying that for example if I just threw that $115 extra toward the principle every month it would benefit me more? I know it would but i feel like I'm not seeing the whole picture.

Thank you for the help.

Chris Mason · Answer

Hi Chris,

Don't let DTI be a big consideration in the points decision. Interest rate doesn't actually move the affordability needle all that much. That's why it's so rare for anyone to say "well, I was qualified, but then rates went up, so now my purchasing power is reduced."

Wayne Brooks · Answer

@Chris Mason I stand corrected....my spotty memory had me thinking the price was heavier than that for buy downs.

Are points on a mortgage worth it?

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