Although mortgage rates have fallen slightly from the highs seen a year ago, they remain very high compared to much of the past decade.
Sure, 6% fixed for 30 years is better than 8% fixed for 30 years, but it’s still a far cry from 3 or 4% fixed for 30 years.
This may explain why potential homebuyers have not rushed into the housing market in recent months.
And now we’re being told that’s as good as it’s going to get for mortgage rates. That remains to be seen, but what’s interesting is that I’ve seen prices drop into the top 4 for mortgage rates recently as well.
So how do lenders manage to advertise interest rates so low if the likes of the Freddie Macs of the world are telling us that interest rates are still above 6%?
Well, the secret is a little thing called mortgage discount points.
Mortgage rates are lower when you pay points
After mortgage rates rose from the start in early 2022, the secondary market where investors buy and sell mortgage-backed securities (MBS) has spiraled out of control.
Essentially, uncertainty and volatility rose while trading volume decreased. In short, MBS investors wanted more collateral, which generally meant borrowers had to pay points up front.
This ensures profit even if the mortgage is short-term and is paid off in a short period of time.
It also allowed lenders to keep mortgage rates from rising, destroying their entire lending volume in the process.
Conditions have improved since then, and it is once again possible to get a home loan today without paying points.
But you still see lenders offering rates with points attached. The reason is that you can offer a lower price!
Obviously it looks a lot better if you are able to advertise a price that starts with 5 instead of 6, or 4 instead of 5.
That’s exactly what some lenders do, at least those that specify the rate rather than the service or brand name.
Interestingly, I discovered over the weekend that this is not a new phenomenon. In the 1980s and 1990s, this was also popular.
Homeowners paid 2 points more on average from 1981 to 1991
Remember the sky-high mortgage rates in the 1980s? Well, if you haven’t, the 30-year fixed yield rose to 18.45% in late 1981, per Freddie Mac.
Despite the rate being astronomically high, the average amount of debit points required at the time was a whopping 2.3.
In other words, on a loan amount of $250,000, you’d be talking about $5,750 in fees just to get that ridiculously high rate.
Does this mean that a borrower who paid just one point would have been subject to the 20% rate? Maybe, I don’t know, but that’s the general way things work.
If you choose to pay less or nothing up front, your mortgage rate will be higher, all other things being equal.
The average points paid by homeowners peaked in 1984 and 1985, when the average amount paid was 2.5 points.
So, for every $100,000 borrowed, a home buyer would have to pay more than $2,500. Again, the mortgage interest rate ended up being around 12 or 14% (it fell a bit after peaking in 1981).
Are mortgage rates that require down payment legitimate?
Now this brings me to the modern era, where lenders still charge multiple points for the lowest rates.
Although it’s not mandatory, as I mentioned, you usually have the option to pay the points at closing.
The trade-off is a lower interest rate if you do this. This is essentially what home builders have been doing to attract business through permanent and temporary price buyouts.
They buy low prices to attract homebuyers, allowing them to keep asking prices steady (or even rising).
Those who compare mortgage rates in stores may also find that some lenders are offering “below market rates” versus what they see in mortgage rate surveys.
The way lenders achieve this is by asking you to pay points upfront, which is a form of prepaid interest.
So the rate offered may be 6% with no points or for a no-cost refinance. But 5.25% if you are willing to pay a point (or more than a point) at closing.
These are completely legit prices, they just cost money to get. This cost is essentially an investment in the mortgage that you will only realize if you hold on to it long enough.
Paying points at closing may not be the best move
While the promise of a lower mortgage interest rate, especially one that starts with the number 4, is tempting, it may not be worth it.
Let’s take a quick example where you pay 2 points to get a 4.875% rate versus a 5.75% rate with no points.
A loan amount of $500,000 would set you back $10,000 at closing.
The monthly payment would be $2,646.04 versus $2,917.86, or approximately $272 per month.
While this is a fair amount of savings, it will take about three years to break even on the initial cost.
Now imagine a steady 30-year decline to the mid-four years or even lower over that period. Or if you want to sell your house and move.
You’ve already paid the lower rate and may not get the full benefit. That doesn’t mean it’s a bad decision, because you and I and everyone else doesn’t know what the future holds.
But you make a conscious decision when you pay points and there are no refunds.
Looking back at those people who paid 2.5 points in 1984 for a 14% rate, only to see rates drop below 10% by 1986, it makes you wonder.
Before creating this site, I worked as an account executive for a wholesale mortgage lender in Los Angeles. My work experience in the early 2000s inspired me to start writing about mortgages 18 years ago to help potential (and current) homebuyers better navigate the home loan process. Follow me on Twitter for hot takes.
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