Mortgage points - looking into the details a bit more

[Anonymous]

Hi, I'm in the process of signing escrow on my new house and have the decision point around interest rates and points. The basic details of the mortgage are:

Purchase amount: $820,850

Down payment: 20% = $164,170

Loan amount: $656,680

Term: 30 yrs fixed

I've been offered the following options to buy points / lower interest:

4.5% (this is the baseline interest rate) = $1,700

4.375% = $4,500

4.25% = $7,800

4.125% = $11,500

4% = $15,400

Tax bracket = 28% and very little in 33%

So i've been playing with some mortgage calculators and here is where I'm confused. A lot of people just look at the payment amount for the points and the length at which you recoup it through the savings of monthly payments. In the case of the 4% interest rate, it lowers my monthly payments by $200 therefore it would require me to live in the house for 68.5 months ((15,400-1,700)/200) therefore 5.66 years where I would be even. So far, this is the calculation that I've seen on all websites and bank documents.

However what my problem with this approach is, is that it's not taking the following into consideration:

- I should be looking at the COST, therefore the payment for the points MINUS the amount that I'll claim back on my taxes next year. So straight away, this will mean (conservatively) (((15,400-1,700))*0.72))/200)=49.3 months=Just over 4 years. Suddenly, this sounds a lot better. But then there is more to it.

- If I then take the 4 years figure and put it into a calculator, the following figures are given:

   At 4.5% interest, I paid 114k interest and 45k principal

   At 4% interest, I paid 101k interest and 49k principal.

So taking this further, if I was to sell my home at the 4th year, I've not only made my initial payment back, but also made 4k on the principal. So really, based on the above, at around mid 3rd year, I'm at zero and from then onwards, I'm making money.

So all in all, I'm really just asking, why all websites are so shortsighted to look at the monthly payments, but not account for the amount of money you didn't pay on interest and also the higher principal balance at the end of each year...?

Or am I missing something very key here and will I be making a huge mistake by paying 15k upfront to then making money after 3.5 years in the home.

I really appreciate if someone can chime in on this as I have to pull the trigger on Monday (2 days from now).

[empiror22]

I didn't check your math fully, but yes you are correct that it's more then just interest / payment amount. If you look at the big picture a lot of times it's better to pay down the rate. But other things to think about is we don't know if tax code will change, ie deductions for paid home loan interest or state paid taxes. These things have it hard for for the basic calculator to process. Also about the calculators, not even one is fully aware of their tax situation and therefore wouldn't know how to fully estimate the differences.

Some other things to think about, if you paid the principal down by the same 14k roughly from your numbers how would that change your payments and interest over the same period in time? This would lower your payment from none buying points therefore lowering the interest paid, but giving you 14 k extra in principle paid. This is almost always better if you'd don't plan on living in the house for at least 5 years.
You have a very complicated question that takes a lot of math to answer and each person is different.

[H-B]

When you do your calculations, you have to see your saving overall. Its not about paying points only and save in interest rate. The average customer come back and refinance or cash out in 5-7 years. You are right about tax bracket and interest saving calculations but calculations are not calculated right because table is  not right. I don't know what is your fico but rates looks little higher. Try to explore arm product with your lender. 

[Anonymous]

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@empiror22 wrote:
I didn't check your math fully, but yes you are correct that it's more then just interest / payment amount. If you look at the big picture a lot of times it's better to pay down the rate. But other things to think about is we don't know if tax code will change, ie deductions for paid home loan interest or state paid taxes. These things have it hard for for the basic calculator to process. Also about the calculators, not even one is fully aware of their tax situation and therefore wouldn't know how to fully estimate the differences.

Some other things to think about, if you paid the principal down by the same 14k roughly from your numbers how would that change your payments and interest over the same period in time? This would lower your payment from none buying points therefore lowering the interest paid, but giving you 14 k extra in principle paid. This is almost always better if you'd don't plan on living in the house for at least 5 years.
You have a very complicated question that takes a lot of math to answer and each person is different.

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Thank you so much for your reply. And you do bring up a good point about the tax code. My personal thought on that is that we almost certainly know it is not changing for 2017 so I will be able to deduct the points at least, so that reduces the loss in the next 30 years should the tax code change on the interest deduction.

So if I take 4.5% ($1,700 paid for points and 13,700 downpayment extra) and 4.0% ($15,400 paid for points but only $13,700 diff compared to 4.50%, no extra downpayment) then the interest and principal balances look like this:

4.5% (interest / principal at year end)

Year 1: $28,7k / $10.3k

Year 3: $84,7k / $32,5k

Year 5:138,6k / $56,8k

Year 10: $262,9k / $128k

4.0% (interest / principal at year end)

Year 1: $26k / $11,5k

Year 3: $76,7k / $36,1k

Year 5:$125,3k / $62,7k

Year 10: $236,8k / $139,3k

Take away is that using that 13,7k or so for downpayment is beneficial for year 1 and half of year 2, but then it's more beneficial to pay down the interest rate instead. I plan to stay longer than 2 years, therefore downpayment would not be beneficial for us.

There is nothing here that cannot be solved with solid math and a number of variables that people could input. I use a mortgage calculator I downloaded from vertex42.com and will submit this thread as a feedback to them so maybe they can include points in their calculator(s) to help people save money..

Thanks again and if you have anything additional to add, I still have 1 day to decide

[Anonymous]

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@H-B wrote:

When you do your calculations, you have to see your saving overall. Its not about paying points only and save in interest rate. The average customer come back and refinance or cash out in 5-7 years. You are right about tax bracket and interest saving calculations but calculations are not calculated right because table is  not right. I don't know what is your fico but rates looks little higher. Try to explore arm product with your lender. 

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My effective credit score for this mortgage right now is 735 (TU). Rate does seem a little high but I've accepted at this stage as there is no time to change lenders, etc. 

Also, please elaborate a little on your thought 'calculations are not calculated right because table is not right'. Not sure what you mean by this?