You’ve done it, you’ve found the perfect home, you’ve submitted the winning offer and you are under contract! If you’ve gotten to this point, you’ve most likely already spoken with your mortgage lender about interest rates during your pre-approval process. Now that you have a set closing date, one of the next conversations your mortgage loan officer will have with you is about current pricing and locking in your interest rate.
Pricing/rates change daily and often fluctuate throughout the day depending on market volatility. For every loan scenario, the lender receives a rate spread. It’s the current pricing available to that borrower, for their particular loan scenario, at that particular time. Often these rate conversations with your loan officer begin with a mention of your “PAR rate”.
The PAR rate is the lowest interest rate you qualify for without paying points. Now, that doesn’t mean that’s your only option. Typically, there will be interest rates available to you that are either higher or lower than the PAR rate. If a borrower opts for an interest rate higher than the PAR rate, most likely they’ll receive what’s called a lender credit. The lender’s credit amount directly reduces the closing costs associated with their loan, costs that are either paid out of pocket at closing or financed into the new loan amount. On the flip side, an interest rate lower than the PAR rate will have an additional cost associated with it. This additional one-time cost is referred to as “points”. In short, if a borrower is paying points, they are buying down their interest rate. 1 point is the equivalent of 1% of the mortgage loan amount. The lower the rate, usually the higher the cost or “points” a borrower is paying for that particular rate. The benefit is the lower interest rate and the resulting lower monthly payment.
While there are many situations where it could make sense, typically it comes down to one question…when is the break-even? Meaning, how far into the loan term (number of payments) does the borrower start to realize a financial benefit from paying that additional up-front cost associated with the lower interest rate selected. You can figure this by comparing the rate scenario in consideration to the next higher rate option. Let’s say, for example, the rate being considered costs $1,400 in points. The next higher rate is PAR, it has no points, but the resulting monthly payment is $30 higher compared to the lower rate option.
The break-even for this example is approximately 46 payments into the loan and here is the math. You divide your additional upfront cost (points) amount of $1,400 by the resulting monthly savings of $30 (1400/30= 46.66). The borrower will recoup the additional upfront cost of $1,400, approximately 46 payments into the loan term, when saving $30 monthly. So, is it worth it? That depends on how long you plan to own the property. In this example, if you think you will own this home for 3 years and no longer, it does not make sense to buy the lower rate because you don’t see a benefit until your 46th payment which is over three years. If it’s your forever home, then it’s a more attractive option.
We’ve talked a bit about points and the importance of considering your “break-even” when deciding if you should buy down your rate. Let’s touch on a few scenarios where it could make sense for a home buyer to pay points. The first one is left over seller credit. If you’ve received a credit from the seller for any reason and if after applying those funds to all applicable closing costs/prepaids, you have funds left over, consider using it to pay points and buy down your rate. You never ever want to leave seller credit funds on the table. That’s your money, put it to good use! Another scenario when paying points might make sense, debt to income ratio is too high. If a borrower is just above the allowable debt to income ratio, it’s time to get creative and find a way to reduce it so their loan will be approved. Buying down the rate (paying points), and lowering the monthly payment may be the solution.
Paying points is not for everyone. It’s a tool that should be discussed and utilized when it presents a benefit to the borrower. To discuss whether paying points makes sense for you on your next mortgage transaction, speak with your mortgage loan professional. That’s what we’re here for!
Spire Financial (A Division of V.I.P. Mortgage, Inc.) brings lending expertise to you. All of our loan officers offer personalized communication for every client, guiding them through the process. We can show you ways to maximize your finances and unlock future opportunities. Spire Financial keeps you in control of refinancing, debt consolidation, and home equity. Together, we can achieve your financial goals.
V.I.P. Mortgage, Inc. DBA Spire Financial does Business in Accordance with Federal Fair Lending Laws. NMLS ID 145502. For state specific licensing, visit www.vipmtginc.com/national-licenses/. V.I.P. Mortgage, Inc. is not acting on behalf of or at the direction of the FHA/HUD or the Federal Government. This product or service has not been approved or endorsed by any governmental agency, and this offer is not being made by any agency of the government. V.I.P. Mortgage, Inc. is approved to participate in FHA programs but the products and services performed by V.I.P. Mortgage, Inc. are not coming directly from HUD or FHA. Information, rates, and programs are subject to change without notice. All products are subject to credit and property approval. Not all products are available in all states or for all loan amounts. Other restrictions may apply. This is not an offer to enter into an agreement. Not all customers will qualify.