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Should
I pay points?
Does a zero-point/zero-fee loan really exist? |
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| The
best way to decide whether you should pay points or
not is to perform a break-even analysis. This is done
as follows: |
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1. |
Calculate the cost of the points.
Example: 2 points on a $100,000 loan is
$2,000. |
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2. |
Calculate the monthly savings
on the loan as a result of obtaining a lower
interest rate. Example: $50 per month. |
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3. |
Divide the cost of the points
by the monthly savings to come up with the number
of months to break even. In the above example,
this number is 40 months. If you plan to keep
the house for longer than the break-even number
of months, then it makes sense to pay points;
otherwise it does not. |
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4. |
The above calculation
does not take into account the tax advantages
of points. When you are buying a house the points
you pay are tax-deductible, so you realize some
savings immediately. On the other hand, when
you get a lower payment, your tax deduction
reduces! This makes it a little difficult to
calculate the break-even time taking taxes into
account. In the case of a purchase, taxes definitely
reduce the break-even time. However, in the
case of a refinance, the points are NOT tax-deductible,
but have to be amortized over the life of the
loan. This results in few tax benefits or none
at all, so there is little or no effect on the
time to break even. |
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| If
none of the above makes sense, use this simple rule
of thumb: If you plan to stay in the house for less
than 3 years, do not pay points. If you plan to stay
in the house for more than 5 years, pay 1 to 2 points.
If you plan to stay in the house for between 3 and
5 years, it does not make a significant difference
whether you pay points or not! |
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| Zero-Point/Zero-Fee
Loans? |
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Whatever
happened to the conventional wisdom of waiting for
the rates to
drop 2% before refinancing? |
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You
have a 30-year fixed loan at 8.5%. A loan officer
calls you up and says they can refinance you to
a rate of 8.0% with no points and no fees whatsoever.
What a dream come true! No appraisal fees, no title
fees and not even any junk fees! Is this a deal
too good to pass up? How can a bank and broker do
this? Doesn't someone have to pay? Whose money is
being used to pay these closing costs?
No––this is not a scam. Thousands of
homeowners have refinanced using a zero-point/zero-fee
loan. Some refinanced multiple times, riding rates
all the way down the curve in 1992, 1993 and, more
recently, in 1996. Some homeowners used zero-point/zero-fee
adjustable loans to refinance and get a new teaser
rate every year.
The way this works is based on rebate pricing, sometimes
also known as yield-spread pricing, and sometimes
known as a service-release premium. The basic idea
is that you pay a higher rate in exchange for cash
up front, which is then used to pay the closing
costs. You will pay a higher monthly payment––so
the money is really coming from future payments
that you will make. |
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You
can also think of this as negative points! For example,
a 30-year fixed loan may be available at
a retail price of : |
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8.0% with
2 points or
8.25% with 1 point or
8.5% with 0 points or
8.75% with -1 point or
9% with -2 points |
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| On
a $200,000 loan, the loan officer can offer you 8.75%
with a cost of -1 point, which is a $2,000 credit
towards your closing costs. A mortgage broker can
use rebate pricing to pay for your closing costs and
keep the balance of the rebate as profit. |
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| What
are the benefits of a zero-point/zero-fee loan? |
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The
main benefit is that you have no out-of-pocket costs.
As a result, if the rates drop in the future, you
could refinance again even for a small drop in rates.
So if you refinanced on the zero-point/zero-fee loan
to get a rate of 8.75% and if the rates drop 1/2%,
you can refinance again to 8.25%. On the other hand,
if you refinanced by paying 1 point and got a rate
of 8.25%, it may not make sense to refinance again.
Now, if the rates drop another 1/2%, a zero-point/zero-fee
loan can drop your rate to 7.75%, whereas if you paid
points, you may have to do a break-even analysis to
decide if refinancing will save you money.
The zero-point/zero-fee loan eliminates the need to
do a break-even analysis since there is no up-front
expense that needs to be recovered. It also is a great
way to take advantage of falling rates.
Some consumers have used zero-point/zero-fee loans
on adjustable loans to refinance their adjustables
every year and pay a very low teaser rate. |
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| What
are the disadvantages of a zero-point/zero-fee loan? |
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| The
main disadvantage is that you are paying a higher
rate than you would be paying if you had paid points
and closing costs. If you keep the loan for long enough,
you will pay more––since you have higher
mortgage payments. In the scenario where you plan
to stay in the house for more than 5 years, and if
rates never drop for you to refinance, you could wind
up paying more money. If, on the other hand, you plan
to stay at a property for just 2-3 years, there really
is no disadvantage of a zero-point/zero-fee loan. |
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| Whose
money is it? |
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Since
you are being paid "cash" up-front in
exchange for a higher rate, it really is your own
money that will be paid in the future through higher
payments. Investors who fund these loans hope that
you will keep the loans for long enough to recoup
their up-front investment. If you refinance the
loans early, both the servicer and the investor
could lose money.
To summarize, zero-point/zero-fee
loans in many cases are good deals. Make sure, however,
that the lender pays for your closing costs from
rebate points and NOT by increasing your loan amount.
So if your old loan amount was $150,000, your new
loan amount should also be $150,000. You may have
to come up with some money at closing for recurring
costs (taxes, insurance, and interest), but you
would have to pay for these whether you refinanced
or not.
Zero-point/zero-fee loans are especially
attractive when rates are declining or when you
plan to sell your house in less than 2-3 years.
Zero-point/zero-fee loans may
not be around forever. Lenders have discussed adding
a pre-payment penalty to such loans, however few
lenders have taken steps to implement such a measure. |
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