Buying $20k worth of mortgage points.

[degrom7]

So we locked in a 30 year fixed rate at 3.625% today on a mortgage loan of $384,000 (20% down payment subtracted from selling price of $480,000) My parents are gifting us $20k and insist that we add it to our 20% down payment of $96k. This addition raises our down payment to 24% at $116k. For me, I rather use that money for my retirement account and my taxable account, but since they're being so generous, I want to obey their wish.

I did the math and this is how much I'll pay after 30 years:
1) Without their gift, I'll pay $630,360 total.
2) If I add $20k to my 20% down payment - I'll pay $597,600 total.
3) If I buy $20k worth of points = 5.2 points = 1.302% reduction which brings my interest rate down to 2.323%, I'll pay $533,520.
4) Not going to do this, but if I put the $20k in a taxable account and get 7% interest and deduct it from #1 above, I would end up paying the least for my 30 year mortgage at $498,115 total.

So it seems buying $20k worth of points will help me reduce my monthly mortgage and help me save $64,000 over a 30 year period instead of adding it to my down payment. Is this a smart move?

A couple of important details about my situation:
- This will be a forever home to live in for decades.
Edit: There's a 10% flip tax of the total price of the home, so I would need to wait years for the home to appreciate enough in order to break even. This ensures that I won't move for awhile.
- At a 3.625 interest rate, I don't anticipate it dropping much lower in the future for a refinance, but then again, people were saying the same thing about the 4.5% interest rates being so low last year.
- My job as a teacher is very stable and I have job protection (tenure) and a future pension.

[hotrodz]

If PMI didn’t exist, would you have put 16% down to use the remaining 4% to buy down points?

I’d put it towards principal and get a smaller loan now. Then take the difference in mortgage payment and invest.

[degrom7]

If PMI didn’t exist, would you have put 16% down to use the remaining 4% to buy down points?

I’d put it towards principal and get a smaller loan now. Then take the difference in mortgage payment and invest.

Yeah I would love to put do that if there was no PMI. So put the money to my principal even though I'll save $64k over the long run by purchasing points?

[Goal33]

Interesting post... I don’t think I’d buy 20k in points but will be curious what others think.

[DesertDiva]

I’ve never liked the idea of buying down points and I don’t know why. Current interest rates already seem so low. I would focus on getting the best rate possible upfront and look very closely at fees. They can vary widely between lenders.

[whodidntante]

- This will be a forever home to live in for decades

It's common to overestimate how long you'll live in a home. Life happens. Preferences change. The people around you change, or come, or go.

[hotrodz]

If PMI didn’t exist, would you have put 16% down to use the remaining 4% to buy down points?

I’d put it towards principal and get a smaller loan now. Then take the difference in mortgage payment and invest.

Yeah I would love to put do that if there was no PMI. So put the money to my principal even though I'll save $64k over the long run by purchasing points?

That’s what I would do. When I bought my first place I went with a 30y mortgage since I couldn’t see myself moving anytime soon. I refinanced 1 year later at 30y 3.625% and 2 years after that we moved out.

If it really turns out to be your forever home then I’d try to pay it in less than 30 years, by adding more to principal whenever possible. Seems like this generous gift is a great opportunity to buy equity instead of buying a better rate, that may or may not matter in a few years.

[unclescrooge]

Get a 7 year adjustable for 3.125%. Chances are very high you will move by then.

Yes, I know you think this is your forever home. Most marriages start if thinking they will last forever too.

[fyre4ce]

Your metric of looking at total interest paid is not correct - it ignores the time value of money. You should be looking at internal rate of return for a decision like this. It will tell you what the equivalent rate of return would be if you instead invested the $20k in a mutual fund.

I built a spreadsheet a while back that calculates the IRR of mortgage points. In general, I found that the IRR was really good over a medium to long period of time, in the range of 15%. The problem is, you need to hold the mortgage (but not necessarily live in the house - you could turn in into a rental) in order to get this return. If you sell the house early, you could get a lower return or even a negative one, saving less interest than you paid in points (losing "principal" if it were a standalone investment). I ran my spreadsheet with your numbers, assuming a 22% marginal tax rate, and that both the points and mortgage interest are tax-deductible. The results are:

Time [yr] | IRR
0 .... -infinity
1 .... -165.01%
2 .... -46.12%
3 .... -14.21%
4 .... -1.20%
5 .... 5.24%
6 .... 8.97%
7 .... 10.90%
8 .... 12.20%
9 .... 13.03%
10 .... 13.56%
15 .... 14.40%
20 .... 14.38%
25 .... 14.28%
30 .... 14.25%

Link to source, my own work

If you sell the house or otherwise pay off the mortgage within a few years, you lose most of your money. Four years is your break-even point. At five years, you're getting a better return than if you had put more money down. At 6-7 years your return is excellent, and at 10 years and beyond you're getting the full return.

So basically, you're making a bet with the mortgage company that you'll keep the mortgage more than 5-6 years. As others have pointed out, life happens, and while most people who buy a house plan to keep it "forever", most do not. You have to look at your situation honestly and try to assess your risk. If you think that you'd convert it to a rental property if you moved, that's extra weight in favor of paying points.

I'd be happy if others checked my numbers and confirmed them or found any mistakes.

Edit: In case it wasn't obvious, the IRR of paying down the principal (any amount, at any time during the life of the loan, including a larger down payment) is equal to the after-tax interest rate. So beyond 5 years, the IRR of the points is much better.

Also consider whether your mortgage interest is deductible. With the $10k SALT cap and the $24,400 standard deduction, any annual mortgage interest below $14,400 will be effectively non-deductible. Your maximum annual interest with this purchase is $13,920 (=$384,000 x 3.625%), so unless you have other Schedule A deductions like charitable donations, none of your mortgage interest will be deductible. That makes both paying principal and points more attractive, but I think it favors points even more. It takes the IRR of paying principal from 2.83% (=3.625% * (1 - 22%)) to the nominal rate of 3.625%, but the IRR of points up to ~21%. It also pulls the payback period for points in to just 39 months.

Contrary to what most others have said, if I were confident at the time of purchase that I'd keep the mortgage for at least 5 years, I'd pay the points; that big fat return is too good to pass up.

Edit again: Paying points also has a cash flow advantage in that your payment is smaller:

Baseline, no $20k: PMT(3.625%/12,360,-384000) = $1,751.24
$20k toward points: PMT(2.323%/12,360,-384000) = $1,482.16 ($267 smaller payment)
$20k toward principal: PMT(3.625%/12,360,-364000) = $1,660.03 ($91 smaller payment)

[Dude2]

A Boglehead principle is to minimize costs. Anything that results in less money you will pay to the lender is moving in that direction. The other principle is to opt for simplicity. You've done the math, but you still have the uncertainty about future rate movements and future return on alternate investments versus paying the loan. It is probably a rare and wonderful event that you have the money to pay discount points at all; however, you will feel terrible if you spend 20k to get to 2.xxx % and then rates drop naturally. You coulda-woulda-shoulda gotten that rate for free, invested the 20k, and made out like a bandit. I assume the motivation of the lender to offer discount points is to derisk their own similar uncertainties. They want your 20k to invest too so they can make out like bandits and laugh behind your back.

As a Boglehead, you are going to put your 20k into the whole market and get a whole market return. You may even be more conservative and select an asset allocation with a certain percentage in bonds. Ok, like you have said, you aim to achieve 7%. The lender probably does not have Boglehead handcuffs on, and maybe they feel they can do more with the 20k. Their aim is higher. From this perspective, your money is worth more to them than it is to you. You have a potential benefit by investing the 20k, but you are only willing to take standard Boglehead risk, limiting the possible outcomes. Therefore, perhaps it would be better for a Boglehead not to bother, and instead take what's on the table -- let the other guys gamble. You have a situation where you will clearly come out ahead in x years based on the deal today, assuming you don't sell or refinance and ignoring all of the future movements and unknowns. I say pay the points and sleep well at night.

[JoeRetire]

My parents are gifting us $20k and insist that we add it to our 20% down payment of $96k.

So it seems buying $20k worth of points will help me reduce my monthly mortgage and help me save $64,000 over a 30 year period instead of adding it to my down payment. Is this a smart move?

You are asking if it's a smart move to not do what your parents are requiring you to do?

That's not a smart move. Just do what you are being required to do and say "Thank You".

[steadyeddy]

My parents are gifting us $20k and insist that we add it to our 20% down payment of $96k.

So it seems buying $20k worth of points will help me reduce my monthly mortgage and help me save $64,000 over a 30 year period instead of adding it to my down payment. Is this a smart move?

You are asking if it's a smart move to not do what your parents are requiring you to do?

That's not a smart move. Just do what you are being required to do and say "Thank You".

+1

It doesn’t matter what option maximizes 30 year savings. It only matters what your parents want you to do with their gift.

[Liberty1100]

I'm actually surprised what some people here are saying. I think the much better idea is to follow the original meaning of the gift and put it in the downpayment.

You could "put" that 20k in the downpayment and you just put in 20k less. Up to you. The major benefit for adding to your downpayment is that when you sell the house, you will get it back as part of the proceeds from the sale. It's not gone. Points would be gone after the sale, since your mortgage gets resolved.

Odds are, you are not going to stay in that house for 30 years. In this kind of economy, if you lived in your house for more than 10-15 years (current approximate average of US homeowners), you would surprise me.

You may love it, your family may love it, you may love your mortgage and how little you pay, BUT you can't control plenty of things in this world which may require for you or your family to move.

Plus, you don't know where interest rates are going. You may need to or want to refinance in the future.

[chw]

Do the analysis based on a 10 year life span for the mortgage. The average life of a mortgage is under 10 years. You may intend to keep the mortgage for 30 years, but in reality very few mortgages go to the full term- they get refi’d, or paid off due to sale. Mortgage buy down points rarely work out for the borrower.

[chw]

Get a 7 year adjustable for 3.125%. Chances are very high you will move by then.

Yes, I know you think this is your forever home. Most marriages start if thinking they will last forever too.

+1.

[blaugranamd]

Do the analysis based on a 10 year life span for the mortgage. The average life of a mortgage is under 10 years. You may intend to keep the mortgage for 30 years, but in reality very few mortgages go to the full term- they get refi’d, or paid off due to sale. Mortgage buy down points rarely work out for the borrower.

Agreed, I would run the numbers on a shorter duration and see what kind of risk you are taking. Paying $20k in points might work out better mathematically over 30 years but if something happens and you move in 5-10 years that points money is not recouped when you sell. I know you listed off reasons you won't want to sell (flip cost, etc) but sometimes the unexpected happens and if you know you're already set up to lose $ if you move early because of this cost you're doubling down on risk if you move early buying lots of points.

Also, does your $533k total cost with points include the $20k you spent on points or just the lifetime cost at the new rate?

[bloom2708]

Get a 7 year adjustable for 3.125%. Chances are very high you will move by then.

Yes, I know you think this is your forever home. Most marriages start if thinking they will last forever too.

+1 You might have 3 mortgages and another house in the next 10 years. Many paths ahead. 7 or 10 year ARM. Get the lowest interest rate.

Be flexible on the mortgages and house. Keep the spouse. You will come out ahead in the long run.

[welderwannabe]

Never pay points.

Average lifespan of a mortgage us less than 10 years. Closer to 7 actually.

Investors in mortgages compare the yield to that of a 10 year treasury for a reason...

[Jack FFR1846]

They are gifting this specifically to put onto the principal. Perhaps they plan to do this every year. If it were me gifting with the desire for you to reduce principal and I found that you did whatever you wanted with the money instead, I'd feel greatly disrespected and would never give you a cent again. Maybe a will rewrite while I was at it.

[Quirkz]

They are gifting this specifically to put onto the principal. Perhaps they plan to do this every year. If it were me gifting with the desire for you to reduce principal and I found that you did whatever you wanted with the money instead, I'd feel greatly disrespected and would never give you a cent again. Maybe a will rewrite while I was at it.

As a counterpoint, if I ever give my kids money, I might mention "I think you could use it for X" but once it left my hands I wouldn't bat an eye if they spent it wherever they felt it helped them best. They would have to be choosing something dangerous or illegal before I decided not to give them more money or wrote them out of the will.

[sergio]

When do you break even if you buy the points?

[ray.james]

A dollar that you pay 30 years from now is only worth 55% of today. Assuming 2% inflation. How can the math be same?

This is an absurd way to look at it especially over 30 year horizon. I would put in pre-paid principal.

[HootingSloth]

One other wrinkle to consider: You should try to evaluate the break even date for buying points versus increasing your down payment on an after-tax basis, which can make buying points look relatively more favorable, especially after tax reform. Because of the SALT limit and higher standard deduction, you will be more likely to claim the standard deduction in future years. However, buying points can effectively pull mortgage interest payments into the current year. This bunching effect can make itemizing more favorable for the single year that you enter into the mortgage, effectively lowering the after-tax cost of borrowing. This requires detailed modeling relative to your personal circumstances. However, when I evaluated my numbers (which are not so different from yours), it pulled the break even date forward a few years.

[sergio]

They are gifting this specifically to put onto the principal. Perhaps they plan to do this every year. If it were me gifting with the desire for you to reduce principal and I found that you did whatever you wanted with the money instead, I'd feel greatly disrespected and would never give you a cent again. Maybe a will rewrite while I was at it.

The money was presumably gifted to help them pay off the house/build equity faster and pay less interest over the life of the loan. If there's a "better" way to do it (specifically buying points) than putting it directly toward the down payment, why on earth would you be so offended? It's not like they are using the money on extravagant travel or luxury hand bags. I'd be thrilled if my daughter was OP, did the math, and proposed an even "better" idea than what I came up with. I write "better" in quotes because obviously the bigger down payment vs buying points debate doesn't have a definitive answer.

[Bdouvs]

Increase the down payment.

I purchased a my "forever home" in August 2018 and purchased points to bring a 30 year loan down to 4.25%.

I'm currently in the middle of refinancing to a 20 year, 3.50%, essentially throwing away the money used to purchase the points.

[FrugalConservative]

NEVER PAY POINTS.

The 10yr is down to 1.847 , why pay 20K when rates are so low to begin with?

[cherijoh]

One other wrinkle to consider: You should try to evaluate the break even date for buying points versus increasing your down payment on an after-tax basis, which can make buying points look relatively more favorable, especially after tax reform. Because of the SALT limit and higher standard deduction, you will be more likely to claim the standard deduction in future years. However, buying points can effectively pull mortgage interest payments into the current year. This bunching effect can make itemizing more favorable for the single year that you enter into the mortgage, effectively lowering the after-tax cost of borrowing. This requires detailed modeling relative to your personal circumstances. However, when I evaluated my numbers (which are not so different from yours), it pulled the break even date forward a few years.

Unless things have changed since 2017, not all points are deductible in the year incurred per this Motley Fool article:

The amount paid as points must not exceed the normal rates charged in the area. Any additional amount paid must be deducted over the life of the loan. This would include "buying down" the interest rate on your loan by paying additional points. The normal points would be deductible, while the additional points would be deducted over the life of the loan.

[JimMolony]

Can you stretch with the extra $20k to only take out a 15 or 20 year mortgage? Not only will you pay a lower rate for the loan, but run the amortization schedule - you'll be amazed at how much less interest you'll pay over the life of it.

If you can't stretch the increase in payment, then throw the money at the original loan.

[Inframan4712]

Get a 7 year adjustable for 3.125%. Chances are very high you will move by then.

Yes, I know you think this is your forever home. Most marriages start if thinking they will last forever too.

This!

I've saved thousands of dollars over decades by having adjustable mortgages.

[chevca]

My parents are gifting us $20k and insist that we add it to our 20% down payment of $96k. This addition raises our down payment to 24% at $116k. For me, I rather use that money for my retirement account and my taxable account, but since they're being so generous, I want to obey their wish.

So, why are we or you doing this exercise then?

I'd say them insisting is more than "their wish". Use the money as they are intending for you to use it. There, exercise over.

[tesuzuki2002]

Are you really going to consider taking 30 years to pay this off? You should pay it off in 8 years. You will save far more than you could image that way.

[fyre4ce]

They are gifting this specifically to put onto the principal. Perhaps they plan to do this every year. If it were me gifting with the desire for you to reduce principal and I found that you did whatever you wanted with the money instead, I'd feel greatly disrespected and would never give you a cent again. Maybe a will rewrite while I was at it.

As a counterpoint, if I ever give my kids money, I might mention "I think you could use it for X" but once it left my hands I wouldn't bat an eye if they spent it wherever they felt it helped them best. They would have to be choosing something dangerous or illegal before I decided not to give them more money or wrote them out of the will.

Geez, this seems extremely heavy-handed, bordering on pathological. If your kid ran the numbers and decided your gift have more value buying down the rate than the principal, you’d never give them anything again and write them out of the will? Would you do the same if you gave them money to help buy a Honda Civic and they decided at the last minute to buy an Accord instead? I’m going to teach my kids how to manage money and analyze financial problems, and if they found a better way to get value out of a gift from me, I’d be proud. Giving gifts can be a wonderful thing, but not when it’s used to control other people. I have seen this behavior in my own family, not directly involving me thankfully, and it was awful.

[Broken Man 1999]

They are gifting this specifically to put onto the principal. Perhaps they plan to do this every year. If it were me gifting with the desire for you to reduce principal and I found that you did whatever you wanted with the money instead, I'd feel greatly disrespected and would never give you a cent again. Maybe a will rewrite while I was at it.

As a counterpoint, if I ever give my kids money, I might mention "I think you could use it for X" but once it left my hands I wouldn't bat an eye if they spent it wherever they felt it helped them best. They would have to be choosing something dangerous or illegal before I decided not to give them more money or wrote them out of the will.

Geez, this seems extremely heavy-handed, bordering on pathological. If your kid ran the numbers and decided your gift have more value buying down the rate than the principal, you’d never give them anything again and write them out of the will? Would you do the same if you gave them money to help buy a Honda Civic and they decided at the last minute to buy an Accord instead? I’m going to teach my kids how to manage money and analyze financial problems, and if they found a better way to get value out of a gift from me, I’d be proud. Giving gifts can be a wonderful thing, but not when it’s used to control other people. I have seen this behavior in my own family, not directly involving me thankfully, and it was awful.

Yeah, I agree. Let the gift be used where the one receiving it thinks best served them.

Broken Man 1999

[fyre4ce]

Are you really going to consider taking 30 years to pay this off? You should pay it off in 8 years. You will save far more than you could image that way.

I don’t know much about their situation, but with rates as low as they are, I’d get the 30 year and enjoy the lower payments. Over 15 years it’s very likely a stock/bond portfolio will outperform a 2.3% interest rate. It’s a good protection against inflation. If after 15 years they have the cash and are sick of the mortgage, they can pay it off in a lump sum. With rates being low generally, and a small spread between 30 year mortgages and shorter terms, I like the 30 year.

To whose who don’t like the paying points option, my math says he’ll break even after 39 months and get a ~20% after-tax return in less than 10 years. Anyone have math that says different?

[Jags4186]

There’s a good chance you’ll be able to no cost refinance to a lower rate in the near future so why you’d voluntarily pay to lower rate makes no sense to me.

When the choice is to give the bank $20k or yourself $20k always choose yourself.

[02nz]

Are you really going to consider taking 30 years to pay this off? You should pay it off in 8 years. You will save far more than you could image that way.

I don’t know much about their situation, but with rates as low as they are, I’d get the 30 year and enjoy the lower payments. Over 15 years it’s very likely a stock/bond portfolio will outperform a 2.3% interest rate. It’s a good protection against inflation. If after 15 years they have the cash and are sick of the mortgage, they can pay it off in a lump sum. With rates being low generally, and a small spread between 30 year mortgages and shorter terms, I like the 30 year.

To whose who don’t like the paying points option, my math says he’ll break even after 39 months and get a ~20% after-tax return in less than 10 years. Anyone have math that says different?

Nerdwallet calculator (https://www.nerdwallet.com/blog/mortgag ... alculator/) says breakeven is 9.2 years. A lot can happen in 9 years, and this is a bet I'd never take myself.

[fyre4ce]

Are you really going to consider taking 30 years to pay this off? You should pay it off in 8 years. You will save far more than you could image that way.

I don’t know much about their situation, but with rates as low as they are, I’d get the 30 year and enjoy the lower payments. Over 15 years it’s very likely a stock/bond portfolio will outperform a 2.3% interest rate. It’s a good protection against inflation. If after 15 years they have the cash and are sick of the mortgage, they can pay it off in a lump sum. With rates being low generally, and a small spread between 30 year mortgages and shorter terms, I like the 30 year.

To whose who don’t like the paying points option, my math says he’ll break even after 39 months and get a ~20% after-tax return in less than 10 years. Anyone have math that says different?

Nerdwallet calculator (https://www.nerdwallet.com/blog/mortgag ... alculator/) says breakeven is 9.2 years. A lot can happen in 9 years, and this is a bet I'd never take myself.

Their calculator ignores the fact that you pay down the principal faster with the lower rate. Not only is the payment smaller with the lower rate, but on the front end of the term, a larger percentage of the payment goes toward principal. Think about the amortization curves - the higher the rate, the more curvy it is and the shallower the slope during the first half of the term. With a 0% rate, it’d be a straight line. So if you model selling the house after 8 years, you also have to add in the additional equity you’d have compared to the higher rate.

[HornedToad]

I’ve never liked the idea of buying down points and I don’t know why. Current interest rates already seem so low. I would focus on getting the best rate possible upfront and look very closely at fees. They can vary widely between lenders.

Buying points is making two assumptions:
1. You wouldn't have been able to refinance the loan to a better term later. E.g. 2 years into the loan you could have refinanced at a rate you paid $5k points to get but now there's no point.
2. You will stay in the house 30 years

Often times its better to just pay extra on the mortgage because very rarely do you stay in the house 30 years. I would also consider a 7 year ARM and check the breakeven period of paying the same rate as a 30 year FRM but at the 7 year ARM. Usually it's ~10-11 years and if you move after 7 you have paid a substantial amount extra on the mortgage from the lower rate.

[Moneta]

NEVER PAY POINTS.

The 10yr is down to 1.847 , why pay 20K when rates are so low to begin with?

Whoah! Where are you seeing 1.847??

[02nz]

Are you really going to consider taking 30 years to pay this off? You should pay it off in 8 years. You will save far more than you could image that way.

I don’t know much about their situation, but with rates as low as they are, I’d get the 30 year and enjoy the lower payments. Over 15 years it’s very likely a stock/bond portfolio will outperform a 2.3% interest rate. It’s a good protection against inflation. If after 15 years they have the cash and are sick of the mortgage, they can pay it off in a lump sum. With rates being low generally, and a small spread between 30 year mortgages and shorter terms, I like the 30 year.

To whose who don’t like the paying points option, my math says he’ll break even after 39 months and get a ~20% after-tax return in less than 10 years. Anyone have math that says different?

Nerdwallet calculator (https://www.nerdwallet.com/blog/mortgag ... alculator/) says breakeven is 9.2 years. A lot can happen in 9 years, and this is a bet I'd never take myself.

Their calculator ignores the fact that you pay down the principal faster with the lower rate. Not only is the payment smaller with the lower rate, but on the front end of the term, a larger percentage of the payment goes toward principal. Think about the amortization curves - the higher the rate, the more curvy it is and the shallower the slope during the first half of the term. With a 0% rate, it’d be a straight line. So if you model selling the house after 8 years, you also have to add in the additional equity you’d have compared to the higher rate.

You do pay down the principal faster with the lower rate, but I think you're forgetting that this on a loan with a higher starting balance, since that 20K would otherwise have been used to reduce the amount of the loan. After 39 months, you've paid more toward principal but you've also paid more in interest + points, and you have a higher principal remaining. (Below figures are from amortization-calc.com, but I've used others and the figures come out the same, to within a dollar).

For a 364K loan with no points at 3.625%, they'll pay $41,582 of interest in the first 39 months. Balance on loan is $340,840.
For a 384K loan with 20K of points at 2.323%, they'll pay $27,906 of interest, for a total cost of $47,906. Balance on loan is $354,101.

So by going with points they'll have paid about $6,300 more interest, and they'll owe about $13,000 more. That's not break-even.

ETA: I see the mistake you made. If you calculate both loans with a principal of 364K, after 39 mos with the points loan you've paid about an extra $5K in points + interest, but in your mind this was offset by an extra $5K paid toward principal. But there are two fallacies there: 1) How much was paid toward principal doesn't actually matter for calculating the cost of the loan, which is points (if any) plus interest; and 2) That 20K paid toward points has an opportunity cost, as I noted above.

[ThankYouJack]

I did the math and this is how much I'll pay after 30 years:
1) Without their gift, I'll pay $630,360 total.
2) If I add $20k to my 20% down payment - I'll pay $597,600 total.
3) If I buy $20k worth of points = 5.2 points = 1.302% reduction which brings my interest rate down to 2.323%, I'll pay $533,520.
4) Not going to do this, but if I put the $20k in a taxable account and get 7% interest and deduct it from #1 above, I would end up paying the least for my 30 year mortgage at $498,115 total.

So it seems buying $20k worth of points will help me reduce my monthly mortgage and help me save $64,000 over a 30 year period instead of adding it to my down payment. Is this a smart move?

A couple of important details about my situation:
- This will be a forever home to live in for decades.
Edit: There's a 10% flip tax of the total price of the home, so I would need to wait years for the home to appreciate enough in order to break even. This ensures that I won't move for awhile.
- At a 3.625 interest rate, I don't anticipate it dropping much lower in the future for a refinance, but then again, people were saying the same thing about the 4.5% interest rates being so low last year.
- My job as a teacher is very stable and I have job protection (tenure) and a future pension.

That's a ton of money on buying points. I did the opposite and refinanced a bunch at no-cost. I forget what my last interest rate was (I think 3.5%) but it was definitely lower than 3.625 for a 30 year fixed.

I think you're taking a gamble on it being your forever home, rates not dropping (over 30 years), things not changing, not wanting to prepay your home faster than 30 years, refinancing to a 15 or 10 year at some point for a lower rate.

What do the numbers look like if you rates drop to 3.5% a year after you buy your home?

[fyre4ce]

You do pay down the principal faster with the lower rate, but I think you're forgetting that this on a loan with a higher starting balance, since that 20K would otherwise have been used to reduce the amount of the loan. After 39 months, you've paid more toward principal but you've also paid more in interest + points, and you have a higher principal remaining. (Below figures are from amortization-calc.com, but I've used others and the figures come out the same, to within a dollar).

For a 364K loan with no points at 3.625%, they'll pay $41,582 of interest in the first 39 months. Balance on loan is $340,840.
For a 384K loan with 20K of points at 2.323%, they'll pay $27,906 of interest, for a total cost of $47,906. Balance on loan is $354,101.

So by going with points they'll have paid about $6,300 more interest, and they'll owe about $13,000 more. That's not break-even.

ETA: I see the mistake you made. If you calculate both loans with a principal of 364K, after 39 mos with the points loan you've paid about an extra $5K in points + interest, but in your mind this was offset by an extra $5K paid toward principal. But there are two fallacies there: 1) How much was paid toward principal doesn't actually matter for calculating the cost of the loan, which is points (if any) plus interest; and 2) That 20K paid toward points has an opportunity cost, as I noted above.

The "39 months" figure I quoted was the payback period for points relative to paying nothing:

After-tax cost of points, assuming they are deductible @ 22% marginal tax rate = $20,000 * (1 - 22%) = $15,600
Reduction in payment by paying points = $1,751.24 - $1,482.16 = $269.07
Principal remaining with no points @ 39 mo = $359,567.63
Principal remaining with points @ 39 mo = $354,101.15
Total benefit for paying points @ 39 mo = ($269.07 * 39) + ($359,567.63 - $354,101.15) = $15,960.36 (already ~$360 more than was paid originally)

Compared to paying down principal, the payback period of the points is still only 45 months:

After-tax cost of points, assuming they are deductible @ 22% marginal tax rate = $20,000 * (1 - 22%) = $15,600
Reduction in payment by paying points, compared to paying principal = $1,660.03 - $1,482.16 = $177.87
Principal remaining with paying principal @ 45 mo = $337,029.04
Principal remaining with paying points @ 45 mo = $349,297.86
Total paid with paying principal @ 45 mo = $20,000 + 45 * $1,660.03 = $94,701.20
Total paid with paying points @ 45 mo = $15,600 + 45 * $1,482.16 = $82,297.20
Total benefit for paying points, compared to paying principal, @ 45 mo = ($94,701.20 - $82,297.20) + ($337,029.04 - $349,297.86) = $135.18

At 5 years, the benefit is $5,223. At 7 years, it's $13,163. At 10 years, it's $24,522. That's a great return.

If you think interest rates will continue to fall, then it's true paying points isn't nearly as good an idea. But they'd have to fall fast enough that'd you'd refi before 45 months for it to still not be worth it.

[02nz]

You do pay down the principal faster with the lower rate, but I think you're forgetting that this on a loan with a higher starting balance, since that 20K would otherwise have been used to reduce the amount of the loan. After 39 months, you've paid more toward principal but you've also paid more in interest + points, and you have a higher principal remaining. (Below figures are from amortization-calc.com, but I've used others and the figures come out the same, to within a dollar).

For a 364K loan with no points at 3.625%, they'll pay $41,582 of interest in the first 39 months. Balance on loan is $340,840.
For a 384K loan with 20K of points at 2.323%, they'll pay $27,906 of interest, for a total cost of $47,906. Balance on loan is $354,101.

So by going with points they'll have paid about $6,300 more interest, and they'll owe about $13,000 more. That's not break-even.

ETA: I see the mistake you made. If you calculate both loans with a principal of 364K, after 39 mos with the points loan you've paid about an extra $5K in points + interest, but in your mind this was offset by an extra $5K paid toward principal. But there are two fallacies there: 1) How much was paid toward principal doesn't actually matter for calculating the cost of the loan, which is points (if any) plus interest; and 2) That 20K paid toward points has an opportunity cost, as I noted above.

The "39 months" figure I quoted was the payback period for points relative to paying nothing:

After-tax cost of points, assuming they are deductible @ 22% marginal tax rate = $20,000 * (1 - 22%) = $15,600
Reduction in payment by paying points = $1,751.24 - $1,482.16 = $269.07
Principal remaining with no points @ 39 mo = $359,567.63
Principal remaining with points @ 39 mo = $354,101.15
Total benefit for paying points @ 39 mo = ($269.07 * 39) + ($359,567.63 - $354,101.15) = $15,960.36 (already ~$360 more than was paid originally)

Compared to paying down principal, the payback period of the points is still only 45 months:

After-tax cost of points, assuming they are deductible @ 22% marginal tax rate = $20,000 * (1 - 22%) = $15,600
Reduction in payment by paying points, compared to paying principal = $1,660.03 - $1,482.16 = $177.87
Principal remaining with paying principal @ 45 mo = $337,029.04
Principal remaining with paying points @ 45 mo = $349,297.86
Total paid with paying principal @ 45 mo = $20,000 + 45 * $1,660.03 = $94,701.20
Total paid with paying points @ 45 mo = $15,600 + 45 * $1,482.16 = $82,297.20
Total benefit for paying points, compared to paying principal, @ 45 mo = ($94,701.20 - $82,297.20) + ($337,029.04 - $349,297.86) = $135.18

At 5 years, the benefit is $5,223. At 7 years, it's $13,163. At 10 years, it's $24,522. That's a great return.

If you think interest rates will continue to fall, then it's true paying points isn't nearly as good an idea. But they'd have to fall fast enough that'd you'd refi before 45 months for it to still not be worth it.

Sorry, but this is all sorts of wrong. Your calculations discount the cost of the points by the maximum potential tax deduction but don't do the same for the interest paid. That grossly skews the calculation, as the interest paid on the 3.625% loan is of course much higher than on the 2.323% loan, especially over the first several years.

They are very unlikely to get a tax benefit equal to their marginal tax rate * 20K. The standard deduction is 24.4K for a married couple. So let's say they make 4 mortgage payments this year starting in September, that's about $3K this year in interest payments, $20K assuming they can deduct the points in full (see below), and the max 10K in SALT. That's only 33K in itemized deductions, or $8600 more than the standard deduction. They have to have a ton of other deductions to put them above that 24.4K "floor" before they can capture the full benefit of the 20K.

And the 20K probably isn't even deductible this year. The IRS requires that the points not be more than "generally charged," and I think you'd have a very hard time making the case that 5.2% is at a level generally charged. Failing this, it can only be deducted over the life of the loan, greatly reducing or eliminating the potential tax benefit, because of the higher standard deduction.

[fyre4ce]

Sorry, but this is all sorts of wrong.

For one, they will not get a tax benefit equal to their marginal tax rate * 20K. The standard deduction is 24.4K for a married couple. So let's say they make 4 mortgage payments this year starting in September, that's about $3K this year in interest payments, $20K assuming they can deduct the points in full (see below), and the max 10K in SALT. That's only 33K in itemized deductions, or $8600 more than the standard deduction. They have to have a ton of other deductions to put them above that 24.4K "floor" before they can realize the full benefit of the 20K.

And the 20K probably isn't even deductible this year. The IRS requires that the points not be more than "generally charged," and I think you'd have a very hard time making the case that 5.2% is at a level generally charged. Failing this, it can only be deducted over the life of the loan, greatly reducing or eliminating the potential tax benefit, because of the higher standard deduction.

Your calculations discount the cost of the points by the maximum potential tax deduction but don't do the same for the interest paid. That also grossly skews the calculation, as the interest paid on the 3.625% loan is of course much higher than on the 2.323% loan, especially over the first several years.

"All sorts of wrong" might be going a BIT far

With a $24,400 standard deduction and $10,000 SALT limit, that leaves $14,400 "room" for mortgage interest before it becomes deductible. With putting $20k toward principal, he'd pay $13,082.13 interest in the first year, and less each year after that, so interest would never be deductible, assuming no large charitable donations or other Schedule A deductions. With paying the points, he'd pay $8,825.28 interest in the first year. If he meets the "not excessive" requirement, then $14,425.28 (about 3/4) of the points would be deductible. If they have to be spread out over the life of the loan, then I agree the points will most likely be non-deductible.

But even in the worst case that the points are 100% non-deductible, that doesn't change the answer much; the payback period is 58 months:
Principal remaining with paying principal @ 58 mo = $328,531.16
Principal remaining with paying points @ 58 mo = $338,697.54
Total paid with paying principal @ 58 mo = $20,000 + 58 * $1,660.03 = $116,281.55
Total paid with paying points @ 58 mo = $20,000+ 58 * $1,482.16 = $105,965.28
Total benefit for paying points, compared to paying principal, @ 58 mo = ($116,281.55 - $105.665.28) + ($338,697.54 - $328,531.16) = $149.89

At 7 years, he's $8,763 ahead with points, and at 10 years he's $20,122 ahead.

Am I missing anything?

[02nz]

"All sorts of wrong" might be going a BIT far

Well, ok. But at almost 6 years, this is still a bet I wouldn't make. Because there are really two bets here, as I think another poster already pointed out:

1. That OP will stay in this house at least until the break-even point; AND
2. That a no-cost refinance will not at any point in those 6 years be lower than the 3.625% rate.

The first one is not a sure thing even for someone with a stable job. Marriages don't always work out. OP may need more space for kids. Or OP may need to move closer to parents who need care in old age. Life happens.

But the second is an even worse bet. I got what I thought was a great rate in 2009, in the depths of the Great Recession, that I thought would never again be seen in my lifetime. Over the next 5 years or so I refinanced 3 times, each time with zero closing costs (not closing costs wrapped into principal). The lender credit to cover the closing costs meant a very slightly higher rate (maybe 1/8 of a percentage point), but since it was lower than my current mortgage, I came out ahead right away, no break-even point. Of course the clock was "reset," so I had to maintain discipline and put at least some of the savings toward principal, otherwise I could have ended up paying more interest over the life of the loan (in the last refinance I switched to a 15-year). But with that one proviso, you always come out ahead with a no-cost refinance. The point is that instead of buying down the rate in the expectation it will be the best you can get for a while, it's better to keep your options open and refinance if rates drop even a little bit - whether that's a month, a year, or 5 years from now. Can't do that if you sink 20K into points.

[fyre4ce]

"All sorts of wrong" might be going a BIT far

Well, ok. But at almost 6 years, this is still a bet I wouldn't make. Because there are really two bets here, as I think another poster already pointed out:

1. That OP will stay in this house at least until the break-even point; AND
2. That a no-cost refinance will not at any point in those 6 years be lower than the 3.625% rate.

The first one is not a sure thing even for someone with a stable job. Marriages don't always work out. OP may need more space for kids. Or OP may need to move closer to parents who need care in old age. Life happens.

But the second is an even worse bet. I got what I thought was a great rate in 2009, in the depths of the Great Recession, that I thought would never again be seen in my lifetime. Over the next 5 years or so I refinanced 3 times, each time with zero closing costs (not closing costs wrapped into principal). The lender credit to cover the closing costs meant a very slightly higher rate (maybe 1/8 of a percentage point), but since it was lower than my current mortgage, I came out ahead right away, no break-even point. Of course the clock was "reset," so I had to maintain discipline and put at least some of the savings toward principal, otherwise I could have ended up paying more interest over the life of the loan (in the last refinance I switched to a 15-year). But with that one proviso, you always come out ahead with a no-cost refinance. The point is that instead of buying down the rate in the expectation it will be the best you can get for a while, it's better to keep your options open and refinance if rates drop even a little bit - whether that's a month, a year, or 5 years from now. Can't do that if you sink 20K into points.

You don't have to stay in the house to get the benefit from the points. If OP moves and converts the property to a rental, he still gets a big benefit, although the mortgage interest becomes 100% deductible so slightly less.

Rates dropping is a problem for the points strategy. But they would have to drop enough, and quickly enough, to make refinancing within 58 months (4.8 years) worthwhile. Points is a gamble, but one that can pay off well. Even without any tax deduction, $20k points pays a 10% after-tax IRR in 6 years and 15% in 10 years; those are really good numbers. If he thinks his personal and professional situation is stable and isn't confident rates will go down, then that's what I suggest. If not, then sure, do something else with the money.

[Dottie57]

My parents are gifting us $20k and insist that we add it to our 20% down payment of $96k. This addition raises our down payment to 24% at $116k. For me, I rather use that money for my retirement account and my taxable account, but since they're being so generous, I want to obey their wish.

So, why are we or you doing this exercise then?

I'd say them insisting is more than "their wish". Use the money as they are intending for you to use it. There, exercise over.

This!

[Dottie57]

I think this is getting too complicated. Use the money as it is intended. You will then have 20% equity in the house. Pay extra each month to quickly build equity. You end up paying less interest. Maybe the idea of an ARM is good - don’t know.

Enjoy the home.