Will Points Make a Difference?

Will Points Make a Difference?

Lenders typically quote mortgages at a market rate but can offer a lower interest rate loan if the borrower is willing to pay points up-front which is considered pre-paid interest.  These points are generally tax deductible for the year paid when the borrower pays them in connection with buying, building or improving their principal residence.

A point is one-percent of the mortgage amount.  A lender will quote a lower-rate mortgage with a certain number of points.  There is not a standard amount; it is an individual company policy.

A simple comparison of the two alternatives based on the borrower’s ability to pay the points and whether the borrower will stay in the home long enough to recapture the costs will help to determine which loan will provide the cheapest cost of housing.

In the example below, two choices are compared; a 4.25% loan with no points vs. a 4.00% loan with one point.  If the buyer stays in the home at least 69 months, they will recover the $3,150 cost for the point on the lower interest rate.

If the purchaser stays ten years, he’ll save two thousand three hundred dollars over the cost of the point.  A less obvious advantage will be realized because the unpaid balance on the lower interest rate loan will results in an additional $2,076 savings.

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Use this Will Points Make a Difference app to discover whether paying points will make a difference in your situation.  This is an example of a permanent buy-down but temporary buy-downs are also available.  A trusted mortgage advisor can help you determine alternatives.

For more information about the deductibility of points, see IRS Publication 936 and if you’re refinancing a home, there is a section specifically on that.  For advice on your specific situation, contact your tax professional.

More Than Just an Address

More Than Just an Address

For a short time after the housing crisis a decade ago, some homeowners thought the value of home is a place to live rather than an investment.  A home certainly has an appeal as a place to call your own, raise your family, share with your friends and feel safe and secure.  It can be more than an address; it can also be one of the largest investments homeowners have.

Most mortgages apply a portion of the payment toward the principal amount owed in order to pay off the loan by the end of the term.  This acts like a forced savings for the homeowner because as the loan is reduced, the equity grows which increases their net worth.

The other contributor to equity is appreciation.  Most homeowners don’t realize the increase in value until they sell the home or do a cash-out refinance, but the increase is real and part of their equity.  If the expected appreciation is averaged over the anticipated time for the home to be owned, the value of the equity increase can be proportioned annually or monthly.

Combining appreciation and principal reduction with leverage, it’s possible to build a case that a home is definitely an investment.  Leverage is the ability to control a larger asset with a smaller amount of cash using borrowed funds.  It has been described as using other people’s money to increase your yield and it applies to homeowners and investors alike.

The table on the picture above shows that even a modest amount of appreciation combined with the amortization of a loan can cause a substantial rate of return on the down payment and closing costs.

This example assumes a 3% acquisition costs on the home with a 4.5% mortgage rate and the resulting equity at the end of five years.  The larger down payments lower the yield because it decreases the amount of borrowed funds.

If a borrower buys a home that appreciates at 2% a year with a 3.5% down payment on a FHA loan for 30 years, the down payment and acquisition cost factored by the equity will produce a 28% return on investment each year during the five year period.

A home can be many things including an investment.  You can use this Rent vs. Own calculator to see the effect that appreciation and principal reduction can have on a home purchase in your price range.  If you have any questions, I’m a phone call away at (707) 467-3693.