Should borrowers pay points or not?

 

Jan. 7, 2013, 11:36 a.m. EST

Should borrowers pay more mortgage points?

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By AnnaMaria Andriotis

Jumbo borrowers are getting the point.

To lower their interest rates—and potentially save tens of thousands of dollars over the life of the loan—many people are paying discount points upfront.

Izhar Cohen for WSJ.com

Paying one point is generally equal to 1% of the total loan amount, and it often drops the rate on the loan by 0.25 of a percentage point, although reductions can vary by lender. On a $1 million mortgage, for example, borrowers who agree to one point could pay $10,000 upfront to lock in a rate of 3.75%, rather than 4%, which is about the average rate on private 30-year fixed jumbos with no points, according to mortgage-info website HSH.com.
For jumbo borrowers, there are several reasons why points are appealing. They’re more likely to have large cash reserves that make it easier to pay the extra money upfront while maintaining liquidity. Also, the large size of their mortgage means these borrowers stand to save more in interest over the long run by locking in the lowest rate now.
That hypothetical borrower with the 3.75% mortgage rate on a 30-year, $1 million mortgage will save about $143 a month and end up with a roughly $4,630 monthly payment. Longer term, that amounts to a savings of almost $51,500 in interest payments over the life of the loan.
In the past few months, borrowers of private jumbo loans have been paying more points than borrowers of smaller loans, according to Inside Mortgage Finance, a trade publication.

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But paying points doesn’t always lead to savings. Buyers should determine how long they plan to keep the home before they sign up for points. For the money spent on points to be worth it, they’ll need to hold on to the property long enough to first recoup this expense and stay beyond that break-even period to actually pocket savings.
Some borrowers who don’t plan to keep the house for a long period use a reverse strategy: taking a higher-than-market interest rate and getting cash back from the lender. In this market, that could mean agreeing to a 4.25% mortgage rate on the same $1 million loan and getting a one-point rebate, or $10,000. (Borrowers can use these funds for anything, including covering closing costs.) That will result in a higher monthly mortgage payment, but if the borrower sells the home in less than 69 months, he will still come out with more savings from the rebate. Here are other issues borrowers should consider before paying points.

• Shop around to find the biggest discount: Borrowers should ask several lenders for quotes, since interest-rate reductions for a point can vary. Rate discounts can also fluctuate if more than one point is purchased.
• Tailor your own discount: Borrowers can also agree to pay a fraction of a point to get some type of discount on their mortgage rate. Currently, 30-year private jumbo borrowers paying an average 0.27 points (or $2,700 on a $1 million loan, for instance) are getting an average fixed mortgage rate of 3.93%, according to HSH.com surveys. Without this fee, the rate would be closer to 4%.
• The type of mortgage they’re getting: Lenders may offer bigger price breaks to borrowers paying points for loans they put on their books, such as jumbos or adjustable-rate mortgages, says Keith Gumbinger, a vice president at HSH.com. That’s partly because they have more control over the return the mortgage will produce and they may prefer to get a portion of their expected total return today via points rather than in a stream of monthly mortgage payments. “They may use points to produce a more aggressive price to attract borrowers,” he says.
• Building equity: Lower interest rates result in a higher portion of principal being paid down each month. The borrowers are also building equity into their homes faster