How no-cost loans save buyers money when rates drop

Rumor is the Fed might drop short-term rates three times in 2024.

That’s good news for homebuyers as fixed-rate mortgages tend to follow the Fed’s lead.

Today, a well-qualified buyer can get a conventional 30-year, fixed rate of 6.5% with a 1-point cost. Each point represents 1% of the loan amount.

Points represent interest paid in advance. Points also are tax-deductible and are paid in exchange for a lower interest rate.

Points also work in reverse. The lender can push rebate points back to the borrower in exchange for accepting a higher mortgage rate.

If fixed mortgage rates come down later this year, then what?

Did you just throw good money after bad?

On a $600,000 loan at 6.5%, the principal and interest payments equal $3,792. Let’s assume closing costs are $6,000 (in addition to the $6,000 point cost).

Side by side, let’s assume you can get a 7.375% rate without points or any settlement costs, a so-called nocost loan. That payment is $4,144, or $352 higher than the 6.5% rate.

I acknowledge payment affordability and qualifying may critically matter now. If that’s the case, then there’s no point in this exercise.

But if the buyer has decided to buy now regardless of payment affordability, taking advantage of less buyer competition and has his or her eyes on a future refinance (assuming rates come down), then this strategy is worthy of consideration.

If rates don’t drop, then obviously 6.5% was the better deal over time. The math says it would take just over 34 months to break even ($12,000 divided by $352 payment savings).

It’s a big bet, but what if fixed-rate mortgages do drop? And you can get a 6% rate without costs? The payment is $3,597. That’s $195 less than the 6.5% over the remainder life of the loan. Over 39 years, for example, it’s a $67,860 savings should the owner keep the mortgage. Plus the $12,000 in closing costs was saved.

There is one other option to consider if a buyer wants some middle ground and is not certain about mortgage rates tumbling.

That would be 6.99% without points (but including the closing costs