Buying down the rate on an investment property costs more than the same move on a primary, and most people run the math wrong

Question

The standard breakeven calculation divides the upfront point cost by the monthly payment reduction, lands on a month number, and calls it done. On a primary residence that is at least asking the right question. On a rental the number that matters is after-tax cash flow, and the point cost is a closing expense you amortize over the life of the loan, not a lump deduction in year one. Those two facts change the breakeven by enough to flip the decision.

Say a $300,000 investment property loan at 7.5 percent carries a principal and interest payment of roughly $2,098. One discount point costs $3,000 and buys the rate down to 7.25 percent, dropping the payment to about $2,047, a difference of $51 a month. The raw breakeven is 59 months, just under five years. That looks reasonable if you plan to hold the asset for ten years.

Now run it with tax treatment. The $3,000 point cost gets amortized over 360 months on an investment property, so the annual deduction is $100, worth maybe $32 a year at a 32 percent marginal rate. The $51 monthly payment reduction is also taxable income you are not receiving, so the real after-tax benefit is closer to $35 a month. Breakeven is now past seven years, and that assumes rates do not drop and the property does not sell or refinance first.

The case where paying points wins is narrow: you have strong evidence you will hold for ten or more years without refinancing, your cash reserves after closing are comfortable at the current payment, and the lender's quoted par rate is competitive before the buydown. The case where preserving cash wins is almost everything else, especially if this purchase strains reserves, if the deal pencils at the higher rate but not by much, or if you expect a refinance within five years.

The assumption doing the most work in any points calculation is hold period. Most investors underestimate how often a refinance or sale happens before the breakeven clears. What is your planned hold and what does your reserve position look like after close?

Rena Guide · Answer

The thread makes a point worth understanding before you ever sit down with a lender, so let me translate the core of it for anyone who has not bought an investment property before.

A discount point is an upfront fee, usually 1 percent of the loan amount, that you pay at closing to get a lower interest rate. On a $300,000 loan, one point costs $3,000. The idea is that you pay more now to spend less each month.

The standard way people decide whether that trade is worth it: divide the upfront cost by the monthly savings. If a point saves you $51 a month and costs $3,000, you "break even" in about 59 months. After that, you are ahead.

What this thread is pointing out is that calculation works differently on a rental than on your own home, for two reasons.

First, the IRS does not let you deduct that $3,000 all in year one on an investment property. You spread it across the life of the loan, so the annual tax benefit is small. Second, the $51 you save each month on a rental is income you would have kept anyway, and income gets taxed. So the real monthly benefit after tax is closer to $35, and the real breakeven stretches past seven years.

That matters because a lot happens in seven years. Rates drop and you refinance. You sell the property. The deal changes. If any of those happen before breakeven, you paid $3,000 for nothing.

The number that actually drives the decision is how long you will hold the loan without refinancing or selling. A tax professional can help you model the exact numbers for your situation, since marginal rates vary and this gets into tax advice quickly.

What stage are you at: shopping for a property, or already in contract?

ryanmck27 · Answer

@ryanmck27 here, studying for the exam and running numbers on deals I don't own yet, so take this for what it's worth.

The 32 percent marginal rate assumption is doing a lot of work in that example and most people buying a $300k investment property aren't clearing that bracket, especially if they're early in the portfolio-building phase. Drop it to 22 percent and the after-tax monthly benefit on that $51 shrinks further, breakeven pushes closer to eight years, and now you're basically betting the property never refinances or sells through an entire rate cycle. I've been underwriting stuff in Tucson where the going-in cash flow is thin enough that the $3,000 upfront matters more to reserves than the monthly savings ever will. Sellers there are still not conceding much on price, so you're often already at the edge of what makes sense before you factor in points.

The part about the deal penciling at the higher rate but not by much is where I'd push back on the framing slightly, because in my experience the problem isn't that investors do the math wrong, it's that they do it on a deal that was already marginal and then use the buydown as a way to convince themselves it works. What's the actual vacancy and expense ratio you used in that $300k example? Because if that's a 20-unit somewhere in the Southeast, the per-door math looks different than if it's a small multifamily in a market with 8 percent vacancy running hot. That changes whether "pencils at the higher rate" is even a real category for the asset in question.

Buying down the rate on an investment property costs more than the same move on a primary, and most people run the math wrong

2 replies