Mortgage points may help homebuyers lower monthly costs amid high interest rates. How to know if this strategy is right for you

As interest rates have climbed, homebuyers have been confronted with higher borrowing costs.

That has led more home purchasers to opt for one strategy, purchasing mortgage points, as a way to defray higher monthly payments.

Mortgage points let buyers pay an upfront fee to lower the interest rate on their loans. In some cases, sellers will help to buy down rates to help ease transaction costs.

Almost 45% of conventional primary home borrowers bought mortgage points in 2022 to reduce their monthly mortgage payments, a trend that has continued into this year, according to recent research from Zillow.

That is up from 29.6% in 2021, when interest rates were lower.

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The 30-year fixed-rate mortgage currently averages 6.7% according to Freddie Mac, up from 5.8% a year ago. The 15-year fixed-rate mortgage now averages about 6%, up from 4.8% a year ago.

This week, the Federal Reserve decided to pause the interest rate hikes it has put in place to combat high inflation.

As rates stay higher, those who are in the market for a home lose purchasing power. Some experts have urged buyers to consider purchasing mortgage points to lower their monthly payments.

Stephanie Grubbs, a licensed real estate agent at the Zweben team at Douglas Elliman Real Estate in New York, recently did exactly that when one of her clients lowered their asking price.

“This fabulous apartment just had a price reduction, which means you can use those savings to buy down your rate,” Grubbs wrote in the updated ad.

Grubbs, a former financial advisor, said her firm started bringing up the strategy more when the Fed started hiking interest rates.

“In an effort to try to be creative, we talk to sellers about offering to buy down a rate,” Grubbs said.

Other experts say buyers purchasing mortgage points can be a great strategy for the right situation.

That goes particularly if a buyer can afford the extra upfront costs.

Being able to lower that monthly payment can really help give some more wiggle room in people’s budgets and help them reach affordability.

Nicole Bachaud

senior economist at Zillow

Mortgage points refer to the percentage amount of the loan. Typically, one point is worth 1% of the loan value, according to Nicole Bachaud, senior economist at Zillow.

If the loan value is $300,000, one point would typically cost $3,000 and lower the interest rate 0.25 percentage points, she said.

“Being able to lower that monthly payment can really help give some more wiggle room in people’s budgets and help them reach affordability,” Bachaud said.

In addition to higher upfront costs, home buyers should also weigh other factors before buying mortgage points.

Set a timeline for living in your new home

“For most instances, it is definitely a considerable cost savings to be able to buy down on points,” said Kamila Elliott, a certified financial planner and co-founder and CEO of Collective Wealth Partners, a boutique advisory firm in Atlanta. Elliott is also a member of the CNBC Financial Advisor Council.

However, if you buy points and then refinance, that will not allow enough time for your upfront payment to appreciate, Elliott said.

Another important consideration is your timeline for how long you plan to live in the home.

With rates and home prices high, that means closing costs are also elevated, Elliott said.

Consequently, if you move before three to five years, you may take a bigger financial hit, she said.

“There could be a huge loss if you can’t stay in that property long enough to have those expenses amortized out over the time that you’re there,” Elliott said.

Consider other alternatives

If you have extra money when buying a home, you may instead choose to increase the size of your down payment.

This can be advantageous because it creates more equity in the home, Bachaud noted. It may also lower your monthly payments.

If that extra money is enough to bring your down payment to 20% of the home purchase price, that would eliminate the need for private mortgage insurance, which adds to monthly costs for mortgage borrowers who put down less than those sums.

However, you may see more of an effect on your monthly expenses by buying points rather than increasing your down payment, Elliott said.

It costs less for a seller to buy down somebody’s mortgage than it does for them to take a price reduction.

Stephanie Grubbs

licensed real estate agent at Douglas Elliman Real Estate

A point may cost $3,000 to $4,000, for example. But putting those sums toward a down payment likely will not make much of a difference on your monthly costs, Elliott said.

If you want to make sure your mortgage payment doesn’t exceed one-third of your take home income, then paying down on points could be the better option, she said.

In some situations, a seller may offer to buy down the rate, a concession to help offset costs for buyers. Grubbs said she has discussed employing this strategy with clients in her real estate practice.

“It costs less for a seller to buy down somebody’s mortgage than it does for them to take a price reduction,” Grubbs said.

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Homebuyers may want to consider pursuing a 2-1 buydown, a mortgage that provides a low interest rate for the first year, a slightly higher rate in the second year and a full rate for the following years.

A 2-1 buydown may also sometimes be seller financed, according to Bachaud.

Talking to a loan officer can help you decide the best decision for your situation, Bachaud said.

Factor in the unknowns

How well any homebuying strategy fares in the long run depends on one big unknown: how the Federal Reserve will handle interest rates going forward.

The latest projections from the central bank call for two more rate hikes this year.

While today’s rates feel high, Elliott said she often reminds people that homebuyers in the 1980s would have loved to have had access to 6% mortgage rates.

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The risky options for Main Street cash, credit, when banks say no to lending

Under current banking and credit conditions, many small businesses are likely being bombarded with pitches for online loans and cash advances. Some of these offers, however, could lead the business down — or further down — the rabbit hole of debt.

Certainly, online lending platforms can make it easier for small businesses to obtain financing, and they serve a key need in a market that has long struggled to get the attention of traditional banks. The recent CNBC|Momentive Small Business Survey found owners saying they had lost confidence in banks as a result of the regional banking crisis, and even more to the point, almost half said it isn’t easy for them to access capital to operate. The debt ceiling fight has introduced another element of economic uncertainty that has small business owners on edge.

Compared with a bank loan, online loan providers typically require fewer hoops for borrowers to go through, more relaxed underwriting standards and a quicker turnaround. The challenge is finding a reputable provider, at a reasonable cost, and with terms that won’t undermine the business’s long-term prospects.

“Some people say you shouldn’t have a credit card, but it’s not the credit card. It’s how you use the credit card. The same is true with online financing,” said Nicole Davis, founder and principal of Butler-Davis Tax & Accounting LLC. 

Here are five things small businesses need to know when considering an online financing offer:

Online loans 

An online loan can be used to fund various business expenses. It’s generally easier to apply and qualify for than a traditional bank loan, and options may exist even if you have less-than-stellar credit. The loan amount can vary, with many ranging between $100,000 and $500,000. Some online loans are 12 months or less, but longer-term options may also be available. These loans generally carry higher interest rates than might be available from a traditional bank or the U.S. Small Business Administration, with annual percentage rates often in the range of 6% to 99%, according to a NerdWallet analysis. Terms are based on the owner’s credit profile, how long the business has been operating, its financials and the amount borrowed, said Travis Miskowitz, a partner in the CFO advisory services group at the accounting and advisory firm Wiss. 

Pay attention to fees that could make the loan more costly, Miskowitz said. These could include an application fee, a good-standing fee to see whether the business is in compliance with local laws, and a credit check fee.

Many lenders may also require a personal guarantee, which can be debilitating in a default and can also impact the owner’s ability to qualify for a personal loan, such as a mortgage. A secured loan could be more advantageous because the rate will likely be lower and the lender might not require a personal guarantee, Miskowitz said.

Merchant cash advance

With a merchant cash advance, companies borrow money against their future sales and pay it back as these sales are generated, often over three to 18 months. A merchant cash advance can be particularly attractive when a small business needs cash fast, generally within a few days, said Alan Wink, managing director of Eisner Advisory Group. This type of funding can also be more accessible to owners with bad credit.

But there are caveats. Terms vary widely by provider and the cost of capital typically isn’t expressed as an APR, making it harder for businesses to understand. Funders charge their fees as a factor rate, generally 1.1 to 1.5, according to NerdWallet.

The advance amount multiplied by the factor rate is what needs to be paid back. But knowing that total doesn’t necessarily help the owner understand how expensive the cash advance is since owners are generally more familiar with APR. Doing a conversion can be useful for comparison purposes. 

A cash advance can be quite costly — in the triple digits when expressed as an APR, according to NerdWallet. 

Fixed vs. variable rate debt

Beyond the type of financing, businesses need to consider whether the rate is fixed or variable, the duration, the business’s ability to pay it back on time, costs, including underwriting and late fees, if any, whether personal or business guarantees are required, and what happens if a payment is missed.

“This is not a scroll-down-and-accept-the-terms-situation,” said Will Luckert, president of small business solutions at Corpay, a corporate payments company. “There can be a number of tricky things buried in the terms and conditions,” Luckert said.

Especially with merchant cash advance, owners get into trouble because they don’t understand what they are signing up for. Start by crunching the numbers on your own. To illustrate, Luckert offers the example of a $10,000 advance where $12,000 needs to be repaid in 30 days. To determine the APR, take $12,000 and divide by $10,000. Then subtract one and multiply by 100. Take that answer, 20 percent, and multiple by 12 to get an APR of 240%. Owners can also use this NerdWallet calculator to help determine what their effective APR would be.

Also consider the repayment frequency — daily, weekly or monthly — especially if you are already in a cash crunch, Davis said. She doesn’t recommend daily repayments, for example, saying, “It’s a quick fix to a problem that can become a ruinous cycle.”

In an attempt to protect small businesses, California now requires certain cost disclosures to merchants. New York is also implementing disclosure rules, even as the California regulations are being challenged in court. In the meantime, it’s still a buyer-beware market. “People need to do the math themselves, especially on a cash advance, and see if there’s anything you can do that would be less expensive,” said Paul A. Rianda, an attorney in Irvine, Calif., who specializes in serving the bankcard industry.

How to find a reputable business loan provider 

To help avoid a bad actor, it’s a good idea to vet potential providers through your CPA or attorney since they likely deal with online providers frequently, Wink said. 

Also look at online customer reviews and browse for regulatory actions against the funding company, said Waseem Daher, chief executive and cofounder of Pilot, which specializes in bookkeeping, tax, and CFO services for high-growth technology startups.

Owners can also check in with the Small Business Finance Association, an industry organization whose 25 members are mostly online lenders and funders. Members of the SBFA have to agree to follow certain best practices related to pricing and term transparency, access to customer service and fair collection, among other things. A small business can contact the SBFA to see if a particular financing company is a member or to ask specific questions about the industry, said Steve Denis, the organization’s executive director.

Additionally, the SBFA has a relatively new certification for industry professionals to help ensure they are properly trained. A database of certified professionals is planned for the future, but in the meantime, owners can contact the SBFA for this information, Denis said. 

Other alternative lending options

Depending on the circumstances, another form of funding might be a better option. This could include family and friends, investor equity or credit cards. Businesses should also think about what can potentially be done to prop up the business without relying on third-parties, Daher said.

Can you get your customers to prepay in exchange for a discount, for example? Can you get longer payment terms from your vendors? Can you do anything else to reduce your costs?

These efforts won’t cost you anything and can help avoid the need to rely on a third-party for funding, Daher said.

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