- The Washington Times - Thursday, August 25, 2005

Q:I read your column advising borrowers not to pay points, and I disagree. First, in

your example, you used a fixed rate. Don’t you know that in the past six months, 74 percent of all borrowers took out adjustable-rate loans?

You should have pointed out that paying three points on a 5/1 adjustable would allow a rate in the low 4 percent range. I think most people would pay the points to get such a low rate.

Also, you failed to mention that points paid by the seller are deductible to the buyer in the first year. Even if the sales price is raised by the amount of the points, the buyer receives a huge tax deduction. Please tell the whole story.

A: We’re going to have to agree to disagree. I’ll do my best to address your issues and explain myself.

The column published Aug. 5 explained that a point is a cash payment to the lender equal to 1 percent of the loan amount in exchange for a lower interest rate.

I argued that taking a higher rate to avoid paying points is a better course of action. I illustrated in an example that it takes more than eight years to recoup the cost of points in the form of a lower interest rate and payment.

This means that if, for any reason, the loan is paid off earlier, the borrower loses money. He can’t refinance and can’t sell.

For most folks, eight years is too long.

Let me address the issue of why I used a fixed rate in the example. Indeed, adjustable-rate products are popular, especially those that carry interest-only payment options. I’m not sure where you get your 74 percent statistic that ARMs are more popular than fixed-rate loans, but that is beside the point.

I am not about to give the impression in this column that an adjustable-rate mortgage is always better than a fixed-rate loan. Everyone has different financial objectives, goals and spending habits, and, thankfully, there are plenty of mortgage programs to suit just about everyone.

Let’s run the numbers and compare a 5/1 ARM with three points and a 5/1 ARM with zero points.

I see that with the payment of three points, a 5/1 ARM would carry an interest rate of about 4.50 percent. A zero-point quote would bring the rate up to about 5.25 percent.

On a loan amount of $300,000, the principal and interest payment at 4.50 percent equals $1,520. At 5.25 percent, the P&I payment rises to $1,657, a difference of $137 per month.

The higher rate saves three points, or $9,000. Divide $9,000 into $137, and we see that it takes almost 66 months, or 5½ years, to recoup the cost of the points in the form of a lower payment.

If the $9,000 were invested and making, say, 3 percent compounded interest, the payback period would extend to at least 80 months.

But wait. This illustration uses a 5/1 ARM product, which means that the rate can adjust after the first 60 months. This means the payback period exceeds the fixed-rate period of the mortgage.

Unless rates are significantly lower in five years, the borrower who takes the lower-rate ARM may never recoup the cost of the points because the rate could be higher in year six.

It is for this reason that it never makes sense to pay points on short- and medium-term ARMs.

Your last point is true. On a purchase transaction, buyers are allowed to deduct any discount points paid, regardless of who pays them. Enticing the seller to pay points by jacking up the sales price does, indeed, give the buyer a good tax break in the first year, but it’s sort of like robbing Peter to pay Paul.

You haven’t convinced me. My advice remains: Think twice before you get sucked into a seemingly low rate that carries thousands in nonrefundable fees.

Henry Savage is president of PMC Mortgage in Alexandria. Contact him by e-mail (henrysavage@pmcmortgage.com).

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