Monday, February 23, 2009

Among The Things I Have Forgotten

In my former life...back in the day...before kids...almost 20 years ago, to be exact...I worked as a mortgage loan processor for a savings and loan association. Do S&L's even exist anymore? I don't think there are any around these parts, at any rate. Maybe they all vanished in the great Crisis. I know the one I worked for got bought up by another S&L, which was bought up by a bank, and who knows what it is now. Wait...this is all starting to sound familiar.

Anyway, way back then, we refinanced a lot of mortgages when the rates were plummeting during the heyday of the Reagan Revolution. When a customer wanted to refinance we tried to help them figure out which combination of rates and points saved them the most interest over the period of time they were likely to own the house. There was a calculation we used to figure a break-even point where it made more sense to go with a higher rate versus paying more points.

As I recall, the way it worked was like this: Customer needs to refi $200K loan. Interest rate X will yield a monthly payment of $1,000 and customer will pay 1 point. Interest rate Y will yield a payment of $1,100 and Customer will pay no points. Since one point would be $2,000 and the difference between the payments is $100/month, the break even point is 20 months. So, if Customer plans to keep the house for longer than 20 months he will save money by going for the lower rate.

So, this makes perfect sense to me if Customer is paying that point in cash at closing. (Although maybe we should take the equation further and estimate how much interest he's losing by not investing the money instead. But we'll assume he banks at Wachovia and gets .05% on his savings account, so it's sort of a non-issue.)

What I can't remember is this: Does this break-even calculation work if Customer is financing the points into the refinanced loan? The points are, in effect, getting spread out over the life of the loan and thereby making the payment higher. But the lower interest rate is also making the payment lower...and that's where my brain got all creaky and started yelling at kids to get off its lawn.

Anybody got an answer for me on this? Any wild guesses? Anyone? Anyone? Bueller??

3 comments:

amy said...

No. You totally made my brain hurt. All I know is that we bought five years ago, we have a good rate, and it hasn't fallen enough to make it worthwhile for us to refinance. And that's about where I stop. :)

Jim said...

Can you finance the points into the loan itself? That would seem to defeat their purpose... In fact, I wouldn't even call them "points" if they're not paid up front.

If you did/could "finance the points," it'd be a relatively straightforward equation to figure out the effective rate (and the breakeven point). Just calculate the cost of the points, then add that to the principal balance before figuring the rest.

Might take two minutes to build a rough spreadsheet... :)

Beth said...

Yes, you can finance the points, and it does seem to defeat the purpose.

And I did all that figuring, including figuring out how much we'd save over the life of the loan.

What was throwing me was that we were saving a bunch more at the lowest rate, even with financing in the points. However, today's rates are showing much higher points so I think the difference will be much less if I calculate it now.

Urgh...this whole thing is driving me crazy. I can't get through to any real people at the banks, online rates are not necessarily accurate, etc. Our current rate is 6.75, and our balance is low enough that it really doesn't pay to mess with this unless we can get below 5.00%.

I have a feeling, no wait...not a feeling. I am *positive* that mortgage loan departments at banks all over the US are in a total uproar while waiting for the details of the big mortgage refi rescue plan. I may have put this off too late...