Buy Point or Don't Buy Point? (loan, interest rate, approved, rate)

[firsttimer99]

So we are waiting our final final decision on our loan. Since we are self employed it has been tricky and required a TON of documentation.

In any case... I want to be prepared. Looks like we're looking at 5.5% interest from FHA.

Is it worth it to buy down to 5.25%?

ie: if loan is $200,000.
Then buying 1/4 percentage point down to 5.25% will cost how much?

And is this worth it? Some folks say no because interest is tax deductible. It seems to me the tax break is greater if you are wealthier.

I'd like to cut the loan down where I can and the best chance is at the beginning right?

Thank you for your responses and I do realize there is probably not a clear cut answer.

[dad2jules]

It's is simply an objective math calculation. A point is a % of your loan amount- if you loan is $200k and you pay 1 point it is $2k. How you calculate benefit is take the $2k and divide by the monthly payment savings to find your breakeven point- X amount of months. My recommendation to clients is 150% of this point. If you can say without question that you will be in the house for that long it is beneficial to you in the long run to pay the point now. I always use 150% because you want cushion to lifes curveballs that come our way.

You should never pay points on an ARM because it is likely you will refinance.

[firsttimer99]

Thanks so much for this info. My CPA agrees completely with your analysis, too btw.

So while we wait to see if we are approved or not I feel like we have a plan taking shape. I like to be prepared.

Thank you so much!

One more question, what is a point equal to in terms of percentage? Is it about 1/2 percentage = 1 point?

[Metrix1234]

I believe it is something like 25 Basis points = 1% more in cost you will have to pay up front.

A basis point is equal to about .001 on your interest rate so I believe it would decrease a 5.5% int rate to 5.25% if I am right..

[firsttimer99]

Ah. So if I understand you correctly, then going down a 1/4 percentage, would cost us 1% of the loan?
Hmm... Definitely worth noting as that is more than I wanted to spend on 1/4 percentage.

[VictorBurek]

Originally Posted by firsttimer99

Ah. So if I understand you correctly, then going down a 1/4 percentage, would cost us 1% of the loan?
Hmm... Definitely worth noting as that is more than I wanted to spend on 1/4 percentage.

I understand where you are coming from, but you will pay that point one way or the other. Either pay it up front and have a lower rate for the life of the loan, or pay it in the form of a higher interest rate for the life of the loan. The higher rate will cost you much more in the long run.

The key to determine whether to pay or not is how long do you plan to keep this home. If you know you are keeping it for 10 to 20 years, then paying the point up front is much better than paying a higher rate for all those years.

Also, the point paid is tax deductible. If you are in a 25% tax brachet,, than deducting $2000 of your income will save you $500 in taxes. That means the $2000 point really only costs $1500.

Do keep in mind, the average a person keeps a home is 4 to 6 years.

[Josh Harmatz]

Difference in rate is $31 per month for approx 1 pt (1%) cost, which is $2000 additional cost for the lower payment and rate. $31 per month x 360 months = $11,160 in additional interest saved for a 5.25%, for only $2000. It definitely pays to take the lower rate, you profit $9,160 by doing so. However, if you plan to be in the home for less than 5 years, it doesn't appear to payoff. For example, the difference in 5.5% and 5.25% is $31 per month. $2000 buy-down cost divided by $31 per month, takes 64 1/2 months to recuperate this additional cost. I hope this helps!

[firsttimer99]

Very informative Josh. Thank you.

And Victor as well. All excellent info. Much appreciated!!