In an effort to provide my readers with truly helpful content, I have asked fellow real estate investor, friend and mentor Richard Scarbrough to help out. And thankfully he has agreed. A frequent guest on the Smarterlandlording Podcast, Richard is a wealth of real estate knowledge. His experience in the business totals over 40 years, and it is perhaps best if I let him describe some of what he has done.
“When I started investing in real estate, there was hardly any information available. I had great desire and blind optimism to do a lot of different things such as buying homes, moving them, infill lot development, apartments (8, 24, 40 and 216 unit complexes) buying and selling mortgages. I thought if I could own 100 homes I would be rich, so I bought homes from Northaven to Southaven (communities here in the Memphis, TN area), any type property, anyway I could finance it. I also bought, rehabbed and flipped to retail buyers over 400 homes. Along the way I tried numerous management companies that always seemed to manage my properties in a way that I had no cash flow. Some of the above ventures lost money (which I call “seminars” ). But what was more important and cost the most was the lost TIME, as it took me almost a decade to get to back to even after the “216 unit apartment seminar.” Now at age 71 looking back at 40 years of investing I realize that about a third and maybe half of my investing time was spent recovering from mistakes, therefore anyway we can educate others to avoid these errors is time well spent.”
So from time to time, I will be publishing some of what I am going to call “Richard on Real Estate.” I hope you will find these posts helpful and entertaining. Let me know what you think or if there is a topic you would like to learn more about by leaving a comment below.
Without further delay then, here is the first in a series of Richard on Real Estate.
SHOULD YOU PAY DISCOUNT POINTS?
Should you pay discount points? Most advisers say no, but you need to look beyond the initial assumption that it’s not a good idea. When you’re getting a loan from a lender, they usually ask “do you want to pay points?” and most people respond “no”, and that ends the conversation. You might want to consider paying points, especially when you’re refinancing, because they could be rolled into the loan and spread out over the term of the loan. What are points? A point is 1% of the loan.
It’s a math problem for me. For a real simple example let’s say you’re borrowing $100,000 and the lender asks, “Do you want to pay one point and it will lower your interest rate 1/4 of 1%?”. Here’s what those words mean, one point is 1% of the loan which is $1,000, so you pay them $1,000 and it lowers your interest rate 1/4 of 1% per year. Now if 1% of $100,000 is $1,000 then 1/4 of 1% is $250, so you pay them $1,000 and it will lower your payment $250 a year, divided by 12, or about $21 a month. So, the question is should I pay them $1,000 to save $21 a month?
I look at the math in two different ways. One, what’s the return on your investment to give them $1,000 to save $250 a year? That’s a 25% return on your investment which is pretty phenomenal. Secondly, how fast will I get my money back? If giving them $1,000 saves me $250 a year, that means I get my money back in four years. As a bonus, on a 30-year loan I’m ahead for the next twenty-six years!
So, your response to “do you want to pay points?” should be “tell me the choices” and then do the math. You may find that you have two, three, or four choices based on a 70%, 75%, or an 80% loan-to-value if you’re an investor, or terms of 15, 20, 25, or 30 years. EACH possible choice may have three or four options of paying points and reducing your interest rate.
The main takeaway is you should always respond with “I might want to pay points, what are my choices?” and figure out the math.
