Why Mortgage Lenders Discourage Buying Points: Future Uncertainty and Cost-Benefit Analysis
Mortgage lenders often advise against purchasing points as a means to lower interest rates, primarily due to the unpredictable nature of the future. While many borrowers may believe they are making a wise financial decision, the reality is that the break-even point for these savings can be several years into the future, potentially beyond the duration of their loan term. In this article, we will explore the reasoning behind this advice and the importance of a cost-benefit analysis.
Initial Consultations and Future Planning
The first step in determining whether to buy points is understanding the borrower's intentions regarding the property. My initial question during the initial consultation is to inquire about the borrower's plans for the property, such as how long they intend to stay in the home. Most people assume a long-term residency of 10 to 20 years, while others might consider it as a temporary home. By knowing the borrower's future plans, we can better assess whether buying down the rate would be a prudent financial decision.
Cost-Benefit Analysis
The decision to buy points involves a complex cost-benefit analysis. For example, a borrower pays a one-time cost of $3,000 to achieve a 0.45% lower interest rate. To break even, the borrower would need to stay in the property for approximately 5.5 years. Given that the average mortgage duration is between 5 to 7 years, the financial wisdom of this move is questionable. The up-front cost could be better utilized elsewhere or saved for future needs.
Impact of Extra Principal Payments
It's also important to consider the potential impact of extra principal payments. If a borrower makes extra principal payments, it can extend the break-even point of the points being purchased. While this reduces the monthly interest payment in the short term, it can make the lower rate less advantageous over the long-term duration of the loan. Therefore, understanding the borrower's financial behavior and potential changes in their debt management is crucial.
Consumer Debt and Cash-Out Refinancing
Borrowers who maintain a significant amount of consumer debt might be more inclined to consider cash-out refinancing to consolidate their debt. In such cases, the borrower would no longer have the original mortgage, which means they wouldn't benefit from the lower rate for a longer period. A financially conservative loan officer should advise against buying points if the borrower is subject to these financial behaviors or plans.
Finding a Balance
Given the unpredictability of future events, such as moves and refinances, it is wise to adhere to a conservative approach. Loan officers should guide their clients to avoid paying discount points unless they are confident that the borrower will be in the property past the break-even point, will not make additional principal payments, and will not refinance the mortgage before reaching that point.
Ultimately, mortgage lenders strive to ensure their clients make financial decisions that are both responsible and informed. By understanding the potential future scenarios and performing a thorough cost-benefit analysis, borrowers can make better-informed choices about their mortgage and reduce financial risks.