SF Peninsula Real Estate Guru

Buyers and homeowners are faced with a myriad of financing options.

There are 30 or 40 year fixed rate mortgages. There are mortgages fixed for 3, 5, 7, or 10 years which then turn into adjustables. There are adjustable rate mortgages where the interest rates adjusts monthly, every 6 months, or every year.

Everyone wants to know: “what loan is best for me?”

In a series of posts to come, I will try to go through many of the questions buyers and homeowners ask when trying to decide which of these financing options is best for them?

Let’s just look at 30 year fixed rate loans for now.

Most lenders will offer several different interest rates based on how many points (also known as loan origination fees) are paid by the borrower.

 A borrower might be faced with the following options:

6.75% at 0 points

6.5% at 1 point

6.0% at 2 points

Which loan is the best deal?

Well, it depends on how long you will have the loan.

Let’s compare the first 2 options (6.75% at 0pts v 6.5% at 1pt).

You will pay 1 point equal to 1% of the loan to reduce your interest rate 1/4%.

So every year you have the lower rate loan, you save 1/4% in interest a year.

So it will take you 4 years of paying 1/4% less in rate to recoup the cost of the 1 point loan fee.

Therefore if you think you will have the loan for less than 4 years, it would be best to pay no points and pay a slightly higher rate. If you think, you will have the loan for more than 4 years, then the 6.5% at 1 point is the better option.

 If you compare the first and third option (6.75% at 0pts v 6.0% at 2 points), one can see that at a cost of 2 points, one would save 0.75% in rate every year. The break even point is therefore 2%/0.75% or 2.67 years or 2 years and 8 months. So if you will have the loan for more than 2 years and 8 months; then getting the 6% at 2 points loan is the better option.

This calculation can be done for any set of rate and terms.

Of course, one might not always be sure they will be in a house or how long they will have the loan. My suggestion might be - when in doubt pay less points. If rates drop you can always refinance into a lower rate. If you pay 2 points and then refinance after 2 years effectively, you will have paid 1% per year additional for that loan.

I will investigate other scenarios in future posts. If you have questions, I would be glad to answer them.