As mortgage rates hit a 23-year high in 2023, more homebuyers paid additional discount points to lower their mortgage rates.
But it might not have been worth it.
More than half of U.S. borrowers paid discount points last year, a significant increase from recent years as they endured the double whammy of soaring home prices and mortgage rates in the 7% range, Freddie Mac said. Discount points, also known as interest rate buydowns, are mortgage interest rates that are paid in advance and deducted from the interest rate at the end of the transaction.
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Even though 2023 homebuyers purchased more points, Freddie Mac found that the interest rate differential was negligible. Through November, the average interest rate for buyers who paid discount points was 6.61%, while the average interest rate for those who did not pay points was 6.69%. The difference is only 8 basis points.
“This result seems to suggest that, from a consumer perspective, paying for discount points may not be worth it,” Freddie Mac researchers wrote.
The report sampled borrowers with credit scores above 740 and loan-to-value (LTV) ratios between 75 and 80. Approximately 59% of purchase borrowers paid discount points in 2023, compared to 31% and 54% of purchase borrowers in 2023, respectively. 2021 and 2022 respectively.
This trend was even more pronounced among people refinancing their mortgages. More than 82% of cash-out refinancers and nearly 60% of non-cash-out refinancers chose interest buydown.
The results highlight how financially stretched some borrowers have been as interest rates soared towards 7% last year, prompting more people to seek last-ditch relief through incentives such as interest rate buybacks. ing.
“With interest rates rising, I think borrowers are looking for ways to alleviate those costs,” Len Kiefer, Freddie Mac's deputy chief economist, told Yahoo Finance. “The fact that they're paying points reflects that we're in a much higher interest rate environment than we've seen in recent years.”
“Discount points may not be worth it.”
Discount points are provided by lenders as an upfront fee calculated as a percentage of the loan amount. By paying points, you pay more upfront, but you receive lower rates in the long run, which can also help reduce your monthly payments.
Typically, the cost of one point is 1 percent of the loan amount. With a $400,000 loan, if he buys one item, he will owe $4,000 at the end. Discount points are typically 0.125% to 0.25% off your interest rate. This means that your 6.75% mortgage interest rate will gradually decrease over the life of your loan, up to a maximum of 6.5%.
“In order to earn that [upfront payment] It's going to take years to undo,” Kiefer said. “Borrowers, especially those who are interest rate sensitive, may have been really focused on their payments.”
Jeffrey Ruben, president of WSFS Mortgage, said the growing trend of buying discount points may have been driven in part by home builders, which carved out most of their salable inventory last year.
read more: 5 Strategies to Get the Lowest Mortgage Rates in 2024
At least 62% of builders offered some form of sales incentive in January, but the measure has hovered between 60% and 62% since October, according to the National Association of Home Builders (NAHB). . Mortgage interest rate buybacks remain the biggest incentive for some housing developers.
For example, Toll Brothers (TOL) is currently offering first-year interest rates as low as 3.99% with its 3/2/1 buyback program on select homes. Interest rates are reduced by 3% in the first year, 2% in the second year, and 1% in the third year. By the fourth year, the interest rate increases to 6.99% and remains fixed until the end of the 30-year term.
That could be an attractive deal for buyers in distress or on the verge of bargaining.
“I think it was led by home builders as a way to help people buy homes at an affordable price,” Reuben told Yahoo Finance. “It's like using mortgage buyout funds to discount your product, (but) keeping prices high. Offering that as an option to buyers is a great way to get people into homes. It is a good tool for
Ruben added: “Builders have had and continue to have a captivated audience.”
“In many cases, it's a waste of money.”
While interest rates are nowhere near the ultra-low levels of the pandemic era, they are slowly coming down from the highs hit in 2023.
So far, interest rates have fallen across the board since October 2023, settling in the mid-6% range now that the new year has begun. Freddie Mac expects mortgage rates to remain in the 6% range throughout the year, unless inflation is contained and there are no economic surprises.
If that's true, some housing experts say it's simply not worth indulging in purchasing discount points.
“I have this discussion every day, several times a day,” Jason Sharon, president of Home Loans Inc., told Yahoo Finance. “In the past, I didn't recommend discount points for his year or so because in many cases it's a waste of money.”
For example, last week, Sharon offered a customer an interest rate of 7.125% with no fees. If his customer wants to buy with his interest rate down to his 6.75%, it will cost him $1,348 in discount points. The monthly savings amount to him $83 per month and the payback period will be 17 months.
“If you can maintain your loan for at least 17 months, you'll get promoted,” Sharon said. “Purchasing discount points is a waste of money if you plan to repurchase or sell within 17 months.”
Another option he offered his clients was to spend $4,800 to lower the interest rate to 6%. This would extend the break-even point to 27 months. In other words, it will take him more than two years to recoup his nearly $5,000 initial cost.
Sharon added, “I don't think that's good behavior. But I'm up to my clients. I'm going to educate and I'm going to serve.”
Gabriela Cruz Martinez I'm a personal finance and housing reporter for Yahoo Finance. Follow her on X @__Gabriela Cruz.
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