I’m going to be like BG and do this cut up your quote and comment on everything….
[quote=harvey]
You don’t need a spreadsheet or “real numbers” to understand the basic tradeoff. Higher up front fees, lower rate. Lower or negative fees, higher rate.
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I agree with this…I don’t think anyone disagrees with this
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Fees are a short term gain, rate is a long term gain. Over time, long term wins. If rates change, then the numbers change, but not the basic tradeoff. And nobody can predict rate changes.
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This is where people disagree. Again, back to where I said “it depends”. Let’s consider the two practice scenarios for a homeowner
Scenario 1: You are buying a home. You need to get a loan for this home.
Should you (a) take out a no (out of pocket) cost loan or should you (b) pay points/cost and get a slightly lower rate loan. What is the best decision?
Scenario 2: You already have a loan on an existing property. Rates for a no-cost-loan fall below 0.25 or more below your original loan. Should you refinance? If so, should pay points/cost to lower the rate even further.
In the case of Scenario (1), there’s really no “for sure” right way of doing this. You might make and educated guess, and the stars might align with your guess, but it’s a crapshoot at best.
1a) On one hand, you could take out a no-cost-loan, and then rates move up, and you won’t be able to refinance. In this scenario, if you kept the house for 30 years, overall, you pay more total interest (assuming paying points/closing costs lower your rate, which it does).
1b) On the other hand, if you paid points and cost, and then rates fall flat on your face and a no-cost-loan rate ends up being much lower than your loan you take out with points and costs, then you just wasted your money paying points and costs. In this scenario, if you don’t refinance, you end up paying more total interest by staying in your original loan that refinance to a low cost loan. But if you did refinance, than the points/cost you paid on the original loan to get a lower rate was useless.
Also, since you brought up present value….
In scenario you paid for points/cost to get a lower rate
a) you are giving up opportunity cost of present day dollars for the amount you paid in points/cost to invest in higher return.
b) You don’t know if you will stay with the entire 30 year loan. If you sell your home or refinance again, your total interest savings from buying down your loan up to ending the loan might be less than the points/cost you paid to lower that rate.
In the scenario you took out a no-cost loan.
a) There the opportunity cost of paying slightly more each month, versus investing better/worse than giving up a lump sum today (as points/cost)
In appear there’s really no clear cut “right” way to do this. “How right” you are in picking depends on how rates moved to your guess and how well you do with your investments of upfront money you would have to pay for points/cost and how long you actually kept that loan (for example, you sell the home or refinance). Since none of us can predict how interest rates will move nor how our investments do, we make an educated guess based on an opinion (supported by our individual interpretations of the what will happen to loan rates and how our individual investments will do).
In Scenario 2, regardless of which kind of loan you took out originally, if rates fall significantly below what your original loan, in the very least you should refinance into something lower than your original loan rate,
if cost(if any)+total interest of old loan is more than cost(if any)+total interest of new loan. a no-cost-loan has immediate benefit compared to your original loan (no matter what kind of loan it was)…. You might be able to pay more points/cost to lower your rate even further, but then again, you run into the same possible scenarios as described above with your first loan, in which there might not be a benefit to doing this because of the other factors.
