On the surface, mortgage points sound like they could be a good deal.
Usually the thinking goes like this:
Pay $2000 up-front to lower my mortgage payments by $30/month?
Why, I could make my money back in 5.5 years!
And the rest is pure profit!
However, this simplistic analysis is what the banks are counting on. It ignores one important element - the opportunity cost of that $2000. Now, I know what you're thinking. Sure I could invest that $2000, but that involves taking risk- paying for points is a sure thing!
But you actually have a sure-bet investment right in front of your eyes. Your home itself.
Yes, every additional $2000 you put down on your purchase is $2000 you don't have to borrow at X% interest.
Your mortgage interest rate is your investment return. At at 5.0% mortgage interest rate, $2000 is worth $100 / year in lower payments / savings.
But that's still not as good as lowering my monthly payment by $30 ($360 per year)! True, but the one final aspect that tips this in favor of not buying points - when you buy points, you LOSE your original $2000 investment, permanently.
So, does investing in home equity beat investing in mortgage points?
Using loan options from AimLoan, we can test this theory.
For the simulation, I assumed a full tax-deduction in year 1 of the mortgage points, for a taxpayer in the 40% bracket - the most generous assumptions which favor mortgage points's tax advantages.
No contest for mortgage equity. The mortgage points barely even catch up after year 30.
But the most damning thing is that for the first 15 years of the loan, you will be much worse off with points if you decide to sell the home or refinance your mortgage at a lower rate.
Investing in mortgage equity is much more flexible, because you retain that equity as an asset.
That equity will be there when you sell, or can re-borrowed through a home equity line of credit.
Possible exceptions? I don't see any.
Redfin is my preferred place to search the MLS, some sites (like Zillow) have old listings that are already under contract. These days great deals are sparse here in Chicago, but I find those sites helpful to keep a pulse on the retail market. Deals that are not listed on major platforms are my primary source of deals now. There are some special places to go online and find these:
Tips For Searching
Word of Mouth Deals
By far some of your best deals could be offline / direct-sourced / word-of-mouth deals. Usually there is a discount here just for being a reliable buyer that will close on the property, and in some cases there are no agent commissions. This is the domain of wholesalers, who use direct mail, driving for dollars, and public records to find and contact property owners who are interested in selling and create their own deal directly. Networking can also put you in contact with various brokers, investors, and property managers who have advance knowledge of when someone is going to sell. Property managers are especially great people to know because they manage a portfolio of investment properties and will usually be one of the first people to know when an investor wants to sell a property. The only way to meet people is to put yourself out there - go to real estate seminars, join local groups, and get active online to meet other real estate professionals.
Most people spend too much time modeling out cash flows. I can understand why, it can be addicting. It feels kind of like fantasizing about something nice that we don’t have. The greed kicks in and we love seeing how much we could make if we owned a certain property.
And for many, it is a good way to get acquainted with real estate. You should analyze as many deals as possible before buying something. Go to open houses. Look up comparable rents in the area. The important thing is to walk yourself through the mental process of buying a house with many different properties. Otherwise how can you really know that one-in-a-hundred deal when it comes up?
Both properties I own, I purchased after a previous investor BACKED OUT OF THE DEAL. Why did they back out? A repair came up in the inspection, perhaps, or the appraisal came in low. It wasn’t something they couldn’t budget for, or work out with the seller. There are always solutions to these problems. But their nerves were already fraying, and when the transaction hit a speed bump, they lost their momentum. They weren’t confident enough that the deal was a good one to move forward.
So that’s really what modeling is for- learning and building your confidence level. But too much reliance on it can be counter-productive. You don’t need to spend a lot of time on it. The deal you eventually buy should be so good that the details are secondary. Real professionals have an intuitive sense of value, and the best deals can be modeled on the back of a napkin.
So go out, model some properties, build your confidence. But try not to get too in the weeds. I’ve attached the model I personally use to get you started.