As mortgage rates launched to 23-year highs in 2023, more homebuyers paid extra discount points to buy down their mortgage rate.
But it may not have been worth it.
According to Freddie Mac, more than half of US borrowers paid discount points last year, a substantial jump from recent years, as they contended with the double whammy of elevated home prices and mortgage rates in the 7% range. Also known as rate buydowns, discount points are mortgage interest you pay upfront at closing to get a small percentage knocked off your rate.
Read more: Should you pay for mortgage discount points? 4 tips on how to decide.
Despite homebuyers in 2023 buying more points, Freddie Mac found that the interest rate differential was negligible. Through November, the average rate for purchase borrowers paying discount points was 6.61%, versus 6.69% for those who didn’t pay points. That’s only an 8 basis point difference.
"This result seems to suggest that paying discount points may not be worth it from the consumers’ point of view," Freddie Mac researchers wrote.
The report sampled borrowers with credit scores of at least 740 and a loan-to-value (LTV) ratio between 75 and 80. About 59% of purchase borrowers paid discount points in 2023, compared with 31% and 54% of purchase borrowers in 2021 and 2022, respectively.
The trend was even more pronounced among people refinancing their mortgages. More than 82% of cash-out refinancers and almost 60% of non-cash-out refinancers chose to buy down their rate.
The results underscore how financially hard-pressed some borrowers may have felt last year as rates surged toward 7%, with more folks looking for a last shot of relief through incentives such as rate buydowns.
"As interest rates have increased I think borrowers are looking for ways that they can try to mitigate those costs," Len Kiefer, deputy chief economist at Freddie Mac, told Yahoo Finance. "When they are paying points it's reflective of the very high interest rate environment we are in relative to recent years."
'Discount points may not be worth it'
Discount points are offered by lenders as an upfront fee that is calculated as a percentage of your loan amount. By paying points, you pay more upfront but can receive a lower rate in the long term, which also helps reduce your monthly payment.
One point typically costs 1% of the loan amount. On a $400,000 loan, purchasing one point translates to $4,000 owed at closing. Discount points typically take between 0.125% and 0.25% off the interest rate. Meaning a mortgage rate of 6.75% would inch down — at most — to 6.5% for the duration of the loan term.
"To earn that [upfront payment] back, it would take many many years," Kiefer said. "It could be that borrowers were really payment-focused, especially those that had any sensitivity to rates."
According to Jeffrey Ruben, president of WSFS Mortgage, the growing trend in purchasing discount points could have been driven, in part, by homebuilders who had carved up most of the inventory available for sale last year.
Read more: 5 strategies to get the lowest mortgage rates in 2024
At least 62% of builders offered sales incentives of all forms in January, a measure which has remained between 60% and 62% since October, according to the National Association of Home Builders (NAHB). Mortgage rate buydowns are still a top incentive with some home developers.
For instance, Toll Brothers (TOL)currently offers a first-year rate as low as 3.99% in its 3/2/1 buydown program on select homes. Rates would be reduced 3% the first year, 2% the second and 1% on the third year. By the fourth year, the rate would increase to 6.99% and remain fixed through the end of the 30-year term.
For buyers in a pinch, or at threat of being priced out, that could be an attractive deal.
"I think it was led a lot by homebuilders, as a way of making home affordability more available for people," Ruben told Yahoo Finance. "It’s like discounting their products by using some funds to buy down the mortgage, (but) keeping the price elevated. Making that an option for buyers is a good tool for them to get people into homes."
Ruben added: "Builders had and continue to have a captive audience."
'In many cases, it's a waste of money'
Even though rates are nowhere near the ultra-lows of the pandemic-era, they are slowly coming down from the highs recorded in 2023.
So far, rates have fallen over a full percentage point from October 2023 and have settled within the mid-6% range as the new year has kicked off. As long as inflation remains muted and there aren’t economic surprises, Freddie Mac predicts mortgage rates should soften throughout the year while sticking above the 6% range.
If that holds true, some housing experts say it really won’t be worth it to indulge in purchasing discount points.
"I have this discussion several times per day, every day," Jason Sharon, president of Home Loans Inc., told Yahoo Finance. "Historically, I have not recommended discount points in a year or so because in many cases they are a waste of money."
For instance, last week Sharon quoted a client at a rate of 7.125% with no fees. If his client wanted to buy the rate down to 6.75%, it would cost $1,348 in discount points. The monthly savings would amount to $83 per month, yielding a 17-month payback time.
"As long as he keeps his loan for at least 17 months, he will come out ahead," Sharon said. "If he refi’s or sells in less than 17 months, purchasing discount points is a waste of money."
Another option he gave his client was to spend $4,800 to buy the rate down to 6%. That would extend the breakeven point to 27 months. In other words, it would take more than two years to recapture that nearly $5,000 upfront cost.
Sharon added: "I just don’t think it’s a good move. However, I leave it up to the client. I educate and serve."
Gabriella Cruz-Martinez is a personal finance and housing reporter at Yahoo Finance. Follow her on X @__gabriellacruz.
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