Although mortgage rates have declined slightly from their highs seen last year, they remain very high compared to most of the past decade.
Sure, a 6% 30-year fixed is better than an 8% 30-year fixed, but it’s still a long way from a 3 or 4% 30-year fixed.
This may explain why prospective home buyers have not returned to the housing market in recent months.
And now we are told that this is as good as it will get in house prices. That remains to be seen, but interestingly I’ve seen quotes in the low-high-4s for loan rates recently.
So how can lenders advertise rates so low when the Freddie Macs of the world tell us rates are still over 6%?
Well, the secret is a little thing called mortgage discount points.
Mortgage Rates Are Lower When You Pay Points
After the rise in mortgage rates since early 2022, the secondary market where investors buy and sell mortgage-backed securities (MBS) went all out.
Basically, uncertainty and volatility increased while volume decreased. Long story short, MBS investors wanted more guarantees, which meant borrowers had to pay points early.
This guaranteed a profit even if the mortgage was short lived and paid off in a short period of time.
It also allowed lenders to keep mortgage rates higher, completely reducing lending volume in the process.
Conditions have improved, and it is also possible to get a home loan today without paying points.
But you still see lenders offering rates with points attached. And the reason is because you can give a lower rate!
Obviously, it looks better if you can advertise a level starting with 5 instead of 6, or 4 instead of 5.
And that’s exactly what some lenders do, at least those that lead by price as opposed to service or brand name.
Interestingly, I found out over the weekend that this is nothing new. Back in the 1980s and 1990s this was common.
Homeowners Paid More than Two Points on Average from 1981 to 1991
Remember those very high mortgage rates in the 1980s? Well if you don’t, the 30 year fixed rate went up to 18.45% in late 1981, with Freddie Mac.
Despite the astronomically high rate, the average number of discount points required during that period was 2.3.
In other words, for a loan amount of $250,000, you’d be talking about $5,750 in fees just to get that ridiculously high amount.
Did that mean that a borrower who paid only one point would be below the 20% rate? Maybe, I don’t know, but that’s usually how it works.
If you choose to make a low or no down payment, the loan amount will be higher, all else being equal.
This average score for homeowners paid peaked in 1984 and 1985, when the average score was 2.5 points.
So for every $100,000 borrowed, the home buyer would have to put down over $2,500. And again, to get the loan amount around 12 or 14% (slightly decreased after the increase in 1981).
Are Real Estate Appraisals That Require Upfront Scores Legal?
Now that brings me to today, when lenders still charge a lot of points at very low rates.
While it’s not mandatory, like I said, you usually have the option to pay points at closing.
The tradeoff is a lower interest rate if you do. This was actually done by the house builders to get into the business for their permanent and short term value.
They buy prices down to attract domestic buyers, allowing them to keep their asking prices constant (or even higher).
Those who compare home prices may find that some lenders are offering “below market rates” compared to what they see in the loan amount survey.
The way lenders achieve this is by asking you to pay points upfront, which is a type of prepaid interest.
So the rate offered might be 6% with no points or no-cost reloads. But 5.25% if you are willing to pay a point (or more than a point) at closing.
These are completely legal values, they just cost money to get. And that cost is an investment in the mortgage that you’ll only see if you hold it long enough.
Paying Points at Closing May Not Be the Best Move
While the promise of a low loan amount, especially one that starts with a 4 is enticing, it may not be worth it.
Let’s consider a quick example where you pay two points to get a rate of 4.875% compared to a rate of say 5.75% without points.
On a $500,000 loan you can get $10,000 back at closing.
The monthly payment will be $2,646.04 compared to $2,917.86, or about $272 per month.
While that’s a decent amount of savings, it can take up to three years to break even on upfront costs.
Now imagine that the 30 year plan falls within the 4s or lower at that time. Or if you want to sell your home and move.
You have already paid a low price and may not get the full benefit. This does not mean that it is a bad decision, as you, me, and everyone else do not know what the future holds.
But you make a conscious choice when you pay points and there are no refunds.
When we look back at those people who were paying 2.5 points back in 1984 at a rate of 14%, and then see rates drop to 10% in 1986, it makes you wonder.
Before creating this site, I worked as an account manager for a real estate broker in Los Angeles. My experiences in the early 2000s inspired me to start writing about mortgages 18 years ago to help prospective (and existing) home buyers better navigate the mortgage process. Follow me on Twitter for the latest.
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