The average 30-year fixed rate mortgage (FRM) rate was 4.05% in March 2017. This was up from 3.71% a year earlier, representing a significant decrease in buyer purchasing power. The Federal Reserve (the Fed) expects to continue taking action to raise interest rates in the coming months and years.
What will happen to the housing market as interest rates continue to inch higher and exert downward pressure on purchasing power?
A recent survey of Redfin agents found that agents expect homebuyers to continue shopping for homes, but at a lower price point than existed under the prior era of lower interest rates.
When homebuyers demand lower prices, home prices eventually fall in line with buyers’ expectations once sellers get over their sticky price delusion. That means a decrease in home prices is on the horizon, likely to be visible in California’s markets by the end of 2017.
The only way this doesn’t happen is for homebuyers to find a way around paying higher interest rates — like buying mortgage points.
Mortgage points to the rescue?
Mortgage points allow the homebuyer to pay an upfront fee to the lender in exchange for a lower mortgage interest rate.
Typically, lenders offer mortgage points at the price of 1% of the homebuyer’s purchase price per one-quarter of a percentage point on the mortgage interest rate.
For example, 1% of a home purchase price of $500,000 is $5,000. A homebuyer who wants to decrease their interest rate by half a percentage point will have to pay the lender $10,000 for two points. With an initial mortgage rate of 5% and a 20% down payment, this reduces the homebuyer’s monthly payment from $2,147 to $2,026 a month.
Are mortgage points a good investment? They can be — but, due to the large upfront fee, it depends on how long your homebuyer plans to stay in the home.
In the example above, the monthly savings of $121 means the homeowner needs to own the home for at least 13.5 years to pay off the points and make this a sensible upfront investment.
There are other benefits as well. Mortgage points paid to obtain a mortgage to fund the purchase of the homebuyer’s primary residence are tax deductible. In turn, taxable income is reduced and the amount of income tax paid is lowered. Generally, the tax savings equals the percentage amount of the deductions at the buyer’s tax bracket rate. [See RPI Form 320-4 §6]
When the points paid on a purchase-assist mortgage for the purchase of the buyer’s primary residence are identified as points on the closing statement, the buyer may deduct the entire amount in the year of purchase.
However, many homebuyers — especially first-time homebuyers — simply don’t have the extra cash on hand to purchase mortgage points to buy down the interest rate. This option is primarily for current homeowners who already have significant equity in their home with enough for a down payment and points.
Agents and brokers: have you noticed an increase in buyers opting to buy mortgage points to decrease their interest rates? Do you expect a growing interest in mortgage points in the coming years as interest rates continue to increase? Share your experience in the comments below!