•  ENT Doc
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I’m in the process of buying a home, and the concept of buying points came up.  While I know this is not generally advised I thought I’d do a spreadsheet on it to share (attached) and to get some thoughts.  The biggest downsides I see are if you don’t live there very long or refinance to a lower rate (provided this opportunity becomes available given what the market does).  However, there appears to be a window for an individual who may *know* they’re going to stay put who may benefit substantially.  The interest deduction scenario assumed every marginal dollar of interest qualified (you were already at or beyond the standard deduction) and benefits occurred at a single marginal rate.  Happy to hear thoughts.  Sorry if it didn’t export well from Numbers.

Edit/Update:  I modified the original version to include the points deduction you get in the year of payment.  This made the initial points cost lower and returns better.

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Xrayman
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This is predominantly a math question and not a tax question.

toatal cost to buy down the points = N

Decreased monthly payment/mortgage with points reduction vs without = Y. Typically takes about 60 months/5 years to make the total cost of initial investment of buying down the Pinots to break even.  Therefore if you  stay for greater than 5 years you will be ahead.  If less than 5 years you will be behind.  Y x 60 > N vs Y x 60 < N

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Kamban
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buying down the Pinots to break even

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In my case it would not last 5 years since it will be consumed rather quickly.  😆

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ENT Doc
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This is predominantly a math question and not a tax question.

toatal cost to buy down the points = N

Decreased monthly payment/mortgage with points reduction vs without = Y. Typically takes about 60 months/5 years to make the total cost of initial investment of buying down the Pinots to break even.  Therefore if you  stay for greater than 5 years you will be ahead.  If less than 5 years you will be behind.  Y x 60 > N vs Y x 60 < N

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This is not accurate.  It is an “all costs” question, inclusive of taxes.  Your decision to buy points and decrease interest brings both the decreased interest expense, but also brings the marginal effect of saving you less in taxes.  As for the break-even analysis, I’m amazed that this is something that the industry puts out.  Break-even analyses don’t taken into account the time value of money.  If your best alternative for the points cost is <0% then sure that break-even point is where you should aim.  That’s not an acceptable alternative for most people.

BCBiker
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I recently refinanced a mortgage.  I was surprised how much the broker fought me on buying points.  It was a thirty year mortgage that we are going to transition to a cashflow rental property in 1-2 years. The math was so obvious in favor of buying points and the guy kept sending back faulty calculation, least of which was the consideration of 0% return on non-spent interest.

This perhaps was a special circumstance.  The owner occupied mortgage rates are significantly lower than what you can get for investment properties so I know that I will not be able to get a better interest rate within the period before breaking even unless rates drop dramatically.  Regardless paying ~\$3000 for 0.5% on a ~\$290,000 note that I plan to pay the expected amortization. It was true that I could have got a 15 year mortgage with similar rate but decided against for various reasons.

The other part to consider is that refinancing is kind of expensive and you have to save a lot in interest to be motivated to go through the hassle and cost of shopping for a better interest rate.  Just my thoughts but I am certain I made the right decision in our case.

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Zaphod
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I recently refinanced a mortgage.  I was surprised how much the broker fought me on buying points.  It was a thirty year mortgage that we are going to transition to a cashflow rental property in 1-2 years. The math was so obvious in favor of buying points and the guy kept sending back faulty calculation, least of which was the consideration of 0% return on non-spent interest.

This perhaps was a special circumstance.  The owner occupied mortgage rates are significantly lower than what you can get for investment properties so I know that I will not be able to get a better interest rate within the period before breaking even unless rates drop dramatically.  Regardless paying ~\$3000 for 0.5% on a ~\$290,000 note that I plan to pay the expected amortization. It was true that I could have got a 15 year mortgage with similar rate but decided against for various reasons.

The other part to consider is that refinancing is kind of expensive and you have to save a lot in interest to be motivated to go through the hassle and cost of shopping for a better interest rate.  Just my thoughts but I am certain I made the right decision in our case.

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As ENTdoc said above, you cant think of it in isolation to your mortgage only. You have to think about whether its worth it vs. say buying more index stocks or bonds, etc….

You paid 3k to get 0.5%, thats fairly expensive in the realm of refis. Its literally a google search to find rates in seconds, shopping is done up front.

In this case the points may have made your property slightly more cash flow positive upfront, and for that purpose may have been more attractive, but as usual every case is different. Much of the time, its sort of a toss up and dependent on lots of variables.

MOX13
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We are looking at buying a house as well here shortly, and I am still confused on this idea of buying points. I get that it brings down the interest rate, but is that just set by each individual lender who much each point brings it down?

JBME
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We bought points. In early 2013 I felt that interest rates were the lowest they’d ever be. I know I could have ended up being wrong but so far since then it’s turned out I was right. So we got a fixed rate. I don’t remember what the original rate was but I know we bought points that I could then deduct on the 2013 tax return. We also felt strongly that while it was our doctor house we were getting just 6 months out of residency, there was a very strong chance we’d be staying. 6 years later and so far we’ve been right. And the points got my fixed interest rate to near 3.25%. I do think in hindsight it was the right decision to buy points. I expect we’ll pay this off in less than 30 years but it’ll probably take at least 15, if not 20, and I’d never refinance as I don’t think we’d ever get a lower rate than around 3.25%

ENT Doc
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We are looking at buying a house as well here shortly, and I am still confused on this idea of buying points. I get that it brings down the interest rate, but is that just set by each individual lender who much each point brings it down?

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Each lender may be different as to how much the interest reduction is per point.  Buying 1 point is typically equivalent to paying 1% of the loan amount.  1/2 a point would be like paying 0.5% of the loan amount, etc.  So if your lender offers a 0.25% rate reduction per point, and your loan was \$500,000 you’d pay \$5,000 up front to get a 0.25% rate reduction.

As for the spreadsheet, the highlighted cells on the left are the only ones you need to complete.  The rest is taken care of by linked calculations.  I just looked at the left column again and for some reason some of the percentages didn’t appear with the decimal to 2 places.  You need to take those out a few decimal places by clicking on the “increase decimal” button at the top.

Loan amount and term are obvious.  The monthly term is necessary to perform some of the other calculations.  The interest rate is an APR.  The monthly rate is your APR/12.  The payment is your monthly mortgage payment prior to any points.  The points are how many points you want to buy and the cost is simply a calculation based on the points % times the loan amount (as in the above example).  The interest reduction per point is determined by your lender.  Interest reduction is based on how many points you buy and how much reduction you get per point.  The new interest rate is the old rate minus your full reduction.  New monthly rate and payment are just as above but calculated for the new APR.  The marginal tax rate is the current marginal tax rate you are operating in financially.

The two columns to the right are “No Interest Deduction” and “Interest Deduction”.  You want to look at whatever column applies to you.  If you benefit from the interest deduction on your taxes then you’d look at that column.  If not then don’t.  The rate you’ll see is the return on your payment for points over a certain number of years.  The interest deduction column is worse because by paying less in interest you don’t benefit from the interest deduction on your taxes, even though your up-front cost for points is lowered by your marginal tax rate (is deductible).

Let me know if you have any other questions.  Buying points is great in a low interest rate environment and when you plan on staying for many years.  Less ability to actually refinance to beat that rate in the future, and the longer you’re there the more benefit you get from a lower interest rate.

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Zaphod
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We bought points. In early 2013 I felt that interest rates were the lowest they’d ever be. I know I could have ended up being wrong but so far since then it’s turned out I was right. So we got a fixed rate. I don’t remember what the original rate was but I know we bought points that I could then deduct on the 2013 tax return. We also felt strongly that while it was our doctor house we were getting just 6 months out of residency, there was a very strong chance we’d be staying. 6 years later and so far we’ve been right. And the points got my fixed interest rate to near 3.25%. I do think in hindsight it was the right decision to buy points. I expect we’ll pay this off in less than 30 years but it’ll probably take at least 15, if not 20, and I’d never refinance as I don’t think we’d ever get a lower rate than around 3.25%

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Felt the same in September of 2016, and felt it was way out of step with the economy. We got a fixed rate at 3.125% without buying points or any other such thing. Pains me that I’ll be selling this place most likely, as its the only time I’ve got on the good side of timing with housing.

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Tim
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But wouldn’t you need to compare to applying the 1% (6k) as downpayment as well? Borrow \$594k, itemized deductions or standard. Just saying, it’s available cash you could invest as well. Spreadsheets are wonderful.

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ENT Doc
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Good point. You could also evaluate the decision to do none of the above and invest the points money instead…

Edit:  You don’t need to evaluate the the decision to invest the points money instead.  The spreadsheet shows the internal rates of return, or hurdle rate for an alternative investment.  The only question to answer is whether you think you can beat those hurdle rates for any given duration.  As for the reduction to the loan option, I think you’ll find that in most situations there is far more power in reducing an interest rate than in reducing the loan amount.  In other words, you have more positive cash flow to you in the buying points decision than in the loan reduction decision.  So while an alternative option for the points cost money, putting the money towards the loan is not likely the ideal choice.

MOX13
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Holy cow, you all are amazing.

With the way interest rates are right now, and looking at a rate of somewhere between 4.125 and 4.35, buying points may make sense. I would say at this point there is a 90% chance we are in this house for over 5 years, 75% chance we are in it over 10 years depending on what we actually buy. It’s our favorite location in the city we will be living in no matter what, and if it can grow enough with our family it will likely be a long term house.

I’ll be plugging some things into that spread sheet tonight or tomorrow, and I’ll let you know ENTdoc if I have questions.

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Zaphod
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Holy cow, you all are amazing.

With the way interest rates are right now, and looking at a rate of somewhere between 4.125 and 4.35, buying points may make sense. I would say at this point there is a 90% chance we are in this house for over 5 years, 75% chance we are in it over 10 years depending on what we actually buy. It’s our favorite location in the city we will be living in no matter what, and if it can grow enough with our family it will likely be a long term house.

I’ll be plugging some things into that spread sheet tonight or tomorrow, and I’ll let you know ENTdoc if I have questions.

Click to expand…

Why would it make sense? Rates rising just reflect a change in the neutral rate, real rates are probably exactly the same. You always have the optionality of refinancing should we hit a recession.

We all think we’re going to be where we’re at when we buy, but sometimes life throws you curve balls.