Mortgage rates are not very low these days. In fact, they’ve basically doubled since early 2022.
While this isn’t good news for aspiring homebuyers or those looking to refinance, it has opened doors to some creative solutions.
Recently, once a very niche product, temporary buying has taken center stage.
And many homebuyers choose to pay discount points at closing to lower their prices.
The question is do you want to lower your price permanently, or do it only temporarily?
Temporary mortgage purchases vs. permanent purchases
First, you need to know the difference between a temporary purchase and a permanent purchase.
Standing Buy (points paid at closing at a reduced rate for the life of the loan)
The standing purchase involves paying discount points at closing to lower the mortgage rate for the life of the loan.
For example, let’s say you take out a loan amount of $500,000, and you get a 6.5% rate on a 30-year fixed-point mortgage.
This will result in a monthly principal and interest payment of $3,160.34.
You’re not too impressed that you’ve seen advertised rates in the 5% range and so you inquire about it.
The loan officer or broker states that you can get a rate of 5.75% if you are willing to pay two discount points at closing.
You owe $10,000 at closing to buy a lower rate mortgage, but you’ll maintain that rate for 30 years.
The payment will drop to $2,917.86, which represents a savings of approximately $250 per month. not bad. But you still need to get $10,000 back!
Temporary purchase (get a discounted mortgage rate in 1-2 years only)
Then there is the temporary purchase process, which as the name suggests temporary. This means that your mortgage rate will only be lower for a short period of time.
In most cases, we’re talking about the first year or two of your loan, which is likely to be a 30-year term.
So for years 28 to 30, the temporary purchase won’t do you any good. And perhaps even worse, the mortgage rate will go back to what it was supposed to be, with no purchase.
For example, if you choose to use the 2-1 buying process, it will temporarily lower your interest rate by 2% in the first year and 1% in the second year.
If the bank rate is 6.5%, you will enjoy a rate of 4.5% in the first year and 5.5% in the second year. But then the savings will end.
You would then be on the hook for the full mortgage rate of 6.5%, which could result in some payment shock.
By shocked, I mean paying a higher amount than I was used to. After all, it’s easy to get used to a lower monthly payment, and then be shocked when it increases.
As a real example, imagine if the loan amount was $500,000. The payment will increase from $2,533.43 to $2,838.95 and finally to $3,160.34.
The saving grace is that it is somewhat gradual because the rate is down 2% the first year, but only 1% the second year.
In this way, the jump in thrust is not so severe. However, it is a very temporary solution to lower payments.
The decision may depend on where prices go next (and where they might go!)
|The loan amount is $500,000||Temporary purchase||permanent purchase|
|mortgage rate||4.5% the first year, 5.5% the second year, 6.5% thereafter||5.75% for the term of the loan|
|Monthly P&I in years 1-2||$2,533.43 in the first year, $2,838.95 in the second year||$2,917.86|
|Monthly P&I in years 3-30||$3,160.34||$2,917.86|
Now that we know how each type of purchase works, we can discuss which ones might be more appropriate for specific situations.
Most proponents of temporary buying point to the high mortgage rates currently on offer.
To that end, they see it as a bridge to a lower mortgage rate in the near future once interest rates come back down.
They argue that you will only need it for a year or two before rates drop and you get a chance to apply for the rate and term of refinancing.
In addition, you only pay for what you will actually use (buying temporary money is put into a buying account and is usually refunded if you sell/buy back before it runs out).
On the other hand, a perpetual purchase may result in you paying for something you don’t actually use.
For example, imagine you pay 2 points at the close ($10,000 in our example), and then prices drop unexpectedly.
Suddenly you get the money to refinance, but you’re hesitant because you paid those non-refundable points up front.
If rates drop enough, say to 5%, you will likely need to eat that cost and go refinance to save even more.
If mortgage rates don’t drop dramatically, you can still lose out if you turn around and sell your holdings before you break even on the initial cost.
At this point, a low purchase rate won’t do you any good either. So you really need to consider how long the home (and the loan) is expected to be before paying points for a permanent purchase.
Can you finance mortgage points?
For the record, there is also the funded perpetual mortgage, which allows you to add points towards the loan amount.
Instead of a $500,000 loan amount, you’ll end up with a $510,000 loan amount in our example. But a lower interest rate will still equal a cheaper payment.
It can increase your purchasing power at the same time, allowing you to buy more home.
While the financing aspect can reduce your cash burden at closing, it still leaves you in the lurch if you refinance or sell soon after.
You are stuck with a larger loan amount if you refinance or less proceeds if you sell. So it’s not quite ideal if you don’t keep the home/loan for a long period of time.
Which options are best?
To sum things up, make sure you understand the difference between a temporary and a permanent purchase to ensure that you’re not paying extra for something you may not use.
Or perhaps buying a home that you may not be able to afford at the effective interest rate!
For those who plan to stay in their homes for a while, a permanent purchase may make more sense.
But that assumes that mortgage rates don’t drop dramatically. Because if they do, refinancing is probably in the cards.
Conversely, if you expect to sell or refinance sooner rather than later, a temporary purchase may be more appropriate.
It reduces the chances of leaving money on the table if you don’t think you’ll make it to break even.
Of course, if prices don’t go down, or even go up (and you don’t sell), you’ll probably wish to buy perpetually.