By Mike Miles
There is more to financing a home than most people think. No single borrower is the same as another, therefore no home loan is the same as another. That may seem challenging to understand, but it’s true.
Borrowers have different variables from each other; credit scores, down payments, length of time they plan to own the home, risk tolerances and housing budgets to name a few. The differentiating variables allow for home loan customization … if you’re working with a lender who knows how to customize that is.
There are a couple customizable segments of a home loan that have a big financial impact for borrowers, and it’s important to be able to identify if the associated math is worth it. These two segments deal with buying down interest rates and how to pay PMI (when applicable).
Let’s start with the idea of buying down interest rates. Rates are offered with a spread every day. In most cases, borrowers choose rates that are equal to a par value. This means the rate doesn’t cost the borrower any money to get nor does it have any premium built in to act as a credit (cash back) to the borrower. As I mentioned, every borrower is different, so each borrower could have a different par-valued rate. It’s possible for borrowers to get rates lower than the par-value rates. This is when a borrower would pay discount points (fees). Paying these fees adds to the cost structure to get a rate at a discounted value. Is it worth it? This is an easy formula but a hard question to answer.
Let’s say the par value rate results in a payment of $1,200 per month. The discounted rate results in a payment that’s $1150 per month; a $50 savings. The cost of the discounted rate is $4500. The break-even point is 90 months (cost / savings). Is it worth it? Will you be in the same house with the same loan for at least 90 months?
The other customizable segment deals with how to pay PMI. Remember, this is an added component of a payment when a borrower doesn’t have 20 percent equity at the time of the loan. Most borrowers that pay PMI do it the traditional way … it being added to the initial payment until the equity reaches 20 percent. However, there are other ways to pay the PMI. What about financing it or paying it as a lump-sum cost at closing? Paying it this way reduces the total amount paid in most cases, but is it worth it?
Let’s say the traditional PMI is $110 per month and will remain on the loan payment for 100 payments (until 20 percent equity is achieved). That’s a total amount spent of $11,000. Paying the PMI in a lump sum could be $5000. The break-even point is 45 months (cost of the lump sum / the monthly cost of the traditional). Is it worth it? Can you afford to pay the cost up front? If not, can you finance it?
The cool thing is that when you work with the proper people, having these customizable options calculated and explained doesn’t take more than a few minutes. It can seem intimidating and demotivating to think about the idea of having lengthy, dense and boring mortgage conversations to have details like this explained. But it is much quicker than you’d think, and being able to determine if the math is worth it can save you thousands.