As mortgage rates continue to climb, discount points are gaining appeal with buyers looking for long-term savings, particularly those who plan to stay put for a while after they buy.
In mid-April, the average rate on 30-year, fixed-rate mortgages rose above 6.5 percent, the highest since July 2002.
Predictions show that rates may rise to 6.9 percent by the fourth quarter, making it even tougher to buy an apartment in Manhattan, where the average price was more than $1.3 million at the end of the first quarter, according to market reports.
According to senior vice president of Preferred Empire Mortgage Company Jeffrey Appel, the rate outlook overall is very likely to continue rising, further diminishing the power of the buyers in a market where prices remain firmly at high levels.
To combat the higher rates, apartment buyers are looking at ways to cut down borrowing costs. “Discount points are one way to buy that power,” Appel said.
Discount points are paid upfront for a mortgage, and for every discount point a borrower pays, the interest rate is typically reduced by a quarter of a percentage point, though it can vary by lender whether it’s a quarter, half, or an eighth of a percentage point.
One point is 1 percent of the loan amount; one point on a $100,000 loan would cost $1,000 upfront.
The long-term savings can be substantial. For example, paying one point on a $100,000 30-year fixed mortgage at 5.75 percent will make monthly payments $584, compared to $600 without the points.
In this scenario, with the savings of $16 a month, a borrower would “make back” the $1,000 in five years, and the savings (by not having to pay a higher interest rate because of the points) throughout the 25-year remaining period of the loan would be substantial.
More buyers are opting to pay discount points to reduce their mortgage rate over time. And lenders can offer anywhere from half a point to even four discount points for borrowers to take advantage of long-term savings. But to take advantage of the discount points, buyers first have to ask themselves how long they plan to stay.
“With discount points, you are saving money in the long haul,” Appel said. “The buyer has to ask themselves whether or not they’ll be receiving the benefit during the time they expect to live there.”
Although discount points are of little use to adjustable rate mortgages, they do benefit buyers who are buying to stay. Many buyers are looking realistically at what the long-term costs are, then paying up front to reduce the rate.
Discount points can also make sense for the seller of a property, especially when a booming residential market reaches a plateau. “The imbalances are going away, making the market healthy in the long-term,” said Walter Molony, spokesman for the National Association of Realtors.
Because of the price plateau and because many newly built condos have hit the market, sellers, including developers selling many units at once, are looking closer at offering points. “Buyers are taking longer to buy, they have more choices,” Appel said. “One way a developer can differentiate their property is to offer discount points.”
With this seller’s concession, buyers will not only save hundreds of dollars a month, but will also save in tax deductions as discount points are basically prepaid interest.
Sellers are turning to offering points instead of slashing prices. This allows the buyer to secure lower interest rates and monthly payments while the selling price remains unchanged. In some neighborhoods, it’s how $350,000 homes are becoming more affordable.
“Sellers are becoming more savvy and sophisticated to the seller’s concession but still giving nothing up,” said Tom Barnhart, president of Mortgage Commitments Inc. “The trend will continue growing when the market softens.”