Mortgage points, known as discount points or “buying down the rate,” are fees paid at closing to a lender to reduce the interest rate and lower your monthly mortgage payment. Generally, one point costs 1 percent of your mortgage amount. The more points you buy, the lower the rate on your loan and the lower your payment.
And what investor doesn’t like having lower expenses and more cash in their pocket?
Know When to Pay Points
In theory, the longer you plan to own the property, paying more points up front helps you save on interest over the life of the loan. Conversely, paying upfront points is expensive and slows your velocity of money.
Let me explain.
Let’s say you purchase a $125,000 property, with 20 percent down, on a fixed rate 30-year mortgage. Here is how your costs, savings, and opportunity costs would look for buying down one and two points.
In both rate buydown scenarios, the savings at the 10-year and 30-year mark is nothing to sneeze at. If the property was your primary home, you would consider the savings involved especially if the loan amount was larger.
However, this home is not our primary, rather an investment property and the debt is outsourced to the tenant. So, let’s look at the opportunity cost of paying this upfront fee.
As long as the property cash flows well (if it doesn’t, let’s have a convo on why you are buying it!), you would actually make a better return investing the money you would use to buy down the rate. In this case, investing the fee to buy down the rate at 8 percent compounded annually would yield multiples over your savings (and you could certainly do better than an 8 percent return).
Decide What’s Right for You
To reach a decision about paying points to lower your mortgage rate on your investment property, do the following.
- Calculate the cost of buying down the rate
- Calculate the principal and interest payment for the respective APRs
- Do the math (see above) to calculate how many months it takes you to break even
- Fees cost / Monthly savings = Number of months to break even
- Calculate your opportunity cost between paying the fee cost and investing the fee cost
There are additional considerations to paying points:
- If you use FHA financing, buying down the rate doesn’t get you out of carrying primary mortgage insurance. Run the numbers both ways to understand which is better—buying down the rate or the PMI
- If you use adjustable rate financing, buying down the rate generally only applies to the loan’s interest rate in the loan’s fixed-rate period. (Therefore, it doesn’t do much good when the rate starts to adjust.)
In the end, under certain circumstances‚ paying points on your loan could save you money if you plan to own the property past the break-even point and are in a fixed-rate mortgage. However, a savvy investor will always ask what the opportunity cost of spending the fees upfront to buy down the interest rate and what return on investment you could you generate in the future.
Do you pay mortgage points—why or why not?
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