| It wasn't that long ago that the prime rate was 4.5 | | | | 6.875 percent loan. Let's apply that math to your deal if |
| percent. Today it's 7.5 percent, 300 basis "points" (3 full | | | | you have a $300,000 mortgage. |
| percentage points) higher. That is a stunning advance, | | | | First of all, let's calculate the point value. It is $300,000 |
| and while mortgage rates are not directly connected | | | | times 4.314 percent or $12,942. If you are buying a |
| to the prime rate, they too have moved up smartly. | | | | new house that means you will need to bring your |
| Now for some fun. You don't have to be completely | | | | closing costs and your $12,942 cash discount to the |
| at the mercy of these advances. There is a tactic that | | | | closing. If you are refinancing, it's likely to be painless if |
| you need to know and understand because it could | | | | those dollars can be plucked out of the equity in your |
| mean that you will be paying the rates prevalent 1 or 2 | | | | house. In either case, your loan will be at 5.625 percent. |
| years ago rather than those of today. It's called "buying | | | | For your protection,ask your banker to provide you |
| down your rate." | | | | with the truth in lending statement and the good faith |
| Here's how it works. | | | | estimate for both the low and high scenarios. Keep |
| Lenders loan you money that they normally do not | | | | both documents for both deals to protect yourself at |
| own. They borrow it from someone else and | | | | closing. (See "Pickpockets," MCG, Jan06, p. 43.) |
| turnaround to "rent" or lend it to you at a slight markup | | | | Critically, make your choice after you have examined |
| in the rate. They make their living on the difference. | | | | these documents and calculated your break-even |
| They can be paid upfront in the form of discount or | | | | point. This way you keep them somewhat honest in |
| origination points (a point is 1 percent of the loan | | | | crafting your deal. |
| amount), or they can be paid by the people who lend | | | | Second, calculate your monthly payment if you pay |
| them the money by loaning you the money at a rate | | | | the full points. In this case a loan of $300,000 that is |
| higher than what they paid. In that latter case, informally | | | | fully amortizing at 5.625 percent will cost you $1,727 for |
| known as being paid "on the back," you could actually | | | | principal and interest each month for 360 months. You |
| end up paying no points for your loan. With those | | | | paid the $12,942 for the privilege of paying this low |
| dynamics, you can easily see that you could be paying | | | | monthly payment. (We are not mentioning payments |
| all points upfront for a loan that is at a rate lower than | | | | for taxes and insurance because they will be the |
| the rate charged to your lender for the money he | | | | same for any financing strategy you pursue.) |
| borrows for your loan, or you could be paying nothing | | | | Third, calculate your monthly payment if you pay no |
| upfront, therefore borrowing the money at a rate | | | | points. In our example a loan of $300,000 that is fully |
| higher than your lender paid. The rate that the lender is | | | | amortizing at 6.875 percent will cost you $1,971 for |
| charged for the money he uses for your loan is called | | | | principal and interest each month for 360 months. You |
| "par." If your lender loans you your money at par,he | | | | paid nothing for this rate. Now for the clincher. Divide |
| makes nothing. The buy down principle works exactly | | | | the points ($12,942) by the difference in the monthly |
| the same if you use it for a 30- year fixed rate or a | | | | payment and determine your break-even point. In this |
| 6-month interest only adjustable rate mortgage (ARM) | | | | case the difference is $244 per month, and your |
| or any deal in between. | | | | break even will occur 53 months into the life of the |
| (It does not really work the same with a pay option | | | | 360- month loan. Your break even is therefore |
| ARM - we will talk about that some other time.) Let's | | | | extremely compelling. Over the life of the loan you will |
| look at today's rate card at United Federal Mortgage, a | | | | save $87,840 if you can just muster$12,942 in discount |
| mortgage bank in Rockville, MD that loans in all 50 | | | | points today.Up for a bonus? Make certain that your |
| states. Let's just look at a 30-year fixed rate loan for | | | | banker characterizes every dollar as a discount point |
| the sake of learning about this tactic. The lowest rate | | | | and not as an origination point. Then chat with your |
| on the rate card is 5.625 percent, a full 187.5 basis | | | | certified public accountant. I bet they will all be |
| points (1.875 percent) below prime. That's dirt-cheap | | | | deductible! In conclusion, next time you are visiting with |
| today. The highest rate on the rate card is 6.875 | | | | your mortgage banker, have him set out the lowest |
| percent,62.5 basis points (or 0.625 percent) below | | | | rate on the rate card next to the highest. Divide the |
| prime. The cost difference between the money | | | | difference in monthly payments into the points required |
| available at those two rates is 4.314 points. Don't look | | | | to buy down the rate. If the break even is acceptable, |
| for a relationship between the cost of the money and | | | | go for the lower rate. Run your own calculation and |
| the rates- your eyes will begin to see ghosts. Just trust | | | | make your own determination. Let the math drive your |
| that the lender will either need 4.314 points upfront for | | | | decision. |
| your 5.625 percent loan or no points at all for your | | | | |