With mortgage rates poised to rise, it might be time to dust off a strategy that could help prospective homeowners afford their new abode.
TransUnion, one of three major credit bureaus, predicted that the average interest rate on a 30-year mortgage would approach 5 percent by the end of 2019.
This rate is a far cry from the heyday of double-digit interest rates in the 1980s, but it’s a noticeable change from where rates were in the last year.
“For a lot of people who have only been around to know the mortgage environment where everything was 4 percent, 5 percent seems pretty dire,” said Monica Sonnier, CPA and member of the American Institute of CPA’s National CPA Financial Literacy Commission.
See below for average historical rates on 30-year mortgages.
Add to that the fact that sales prices on homes have continued to rise — the median listing price for a home is $276,000, as of Nov. 30, according to Zillow.
Enter a strategy that could help potential buyers afford a new home, even as mortgages become more expensive: Paying your lender a fee upfront in order to reduce the interest rate on the mortgage.
This is known as paying “mortgage points” or “discount points.”
“Largely the option for points is often there, but it becomes more a question of whether consumers want to be proactive and ask about them or not,” Joe Mellman, senior vice president and mortgage business leader at TransUnion.
Here’s what you should know about points and whether this move might be right for you.
Each point that you pay is equal to 1 percent of the amount that you’re borrowing. In that manner, one point on a $100,000 mortgage is equal to $1,000 — the amount of money you’ll need to give to your lender when you close on your loan.
Points don’t have to be round numbers; they can be fractional.
The example below from the Consumer Finance Protection Bureau compares a $180,000 mortgage with a 5 percent interest rate and no points to a loan for the same amount with 0.375 of a point and 4.875 percent interest.
In the end, an additional $675 in closing costs will lead to an overall monthly savings of $14, according to the CFPB.
To determine how long it will take to recoup the additional upfront cost of the points — your break-even point — you’ll need to divide the additional amount you paid by the amount of monthly savings.
In that sense, if you spend $2,000 on a point and save $30 a month due to lower interest, it will take you about 66 months or 5½ years to break even.
While points may be deductible on your income tax return, you will need to itemize in order to take the break.
Don’t let the tax deductibility of points drive your decision.
Now that the standard deduction has been raised to $12,200 for single filers and $24,400 for married couples who file jointly (for the 2019 tax year), fewer people are expected to itemize deductions on their returns.
Generally, home buyers need to make a down payment of at least 20 percent of the purchase price in order to avoid the additional monthly cost of private mortgage insurance.
But what if you have enough cash that you’ll need to choose between making a 20 percent down payment or using some of the money to buy points?
“If I put the money into the down payment, I reduce the balance I’m borrowing,” Sonnier said. “If I pay for points, I’ll have a higher balance, but at a lower rate of interest.”
Get out that calculator and compare your monthly savings over the life of the loan. That’s because the additional cost of the private mortgage insurance could cancel out the monthly savings from the points.
Ultimately, whether paying down points makes sense for you will depend on how long you’re staying in the house.
“The rule of thumb is that it takes about five to seven years to break even,” Sonnier said. “If you’re sure you won’t be in that house for five years, then it doesn’t make sense to pay down the points.”