- The Washington Times - Wednesday, January 17, 2007

While visiting the Charleston, S.C., area over the holidays, I picked up a local newspaper and saw an article headlined: “Want to Avoid the Origination Fee? Think Again.”

Having promoted the idea of avoiding origination fees during my entire mortgage career, it perked my interest.

The piece was written by a local mortgage loan officer who works for a very large national bank. The writer basically concluded that it makes more sense to pay at least 1 point in order to receive a lower interest rate.

One point, sometimes called an origination fee, is equal to 1 percent of the loan amount, paid upfront at the time of closing in cash or by raising the loan amount. The more points paid, the lower the interest rate.

There were a few errors and unrealistic assumptions in this fellow’s numerical example. He used an example of a \$500,000, interest-only adjustable rate mortgage (ARM).

Paying no points, he quoted an interest rate of 6 percent. The interest payment is \$2,500 per month.

He then suggested that by paying 1 point origination fee, equal to \$5,000, the interest rate would drop to 5.50 percent.

The payment drops to \$2,292 per month — a difference of \$208 per month. Basically, a \$5,000 initial investment saves \$208 per month over the life of the loan. By dividing \$5,000 into \$208, the writer concludes that the borrower will recoup his origination fee in only 24 months.

After that, the \$208 is gravy.

This is where his logic begins to go awry.

First, unless the loan amount increases to \$505,000, the borrower must pay the \$5,000 origination fee out of pocket. Surely \$5,000 — a lot of money — can be invested to make a modest return, perhaps 3 percent at a minimum.

Since this money would no longer be there to invest, the borrower loses \$150 per year, or about \$13 per month, in rounded dollars, in investment potential.

This effectively shrinks the difference in monthly payment to \$195.

There’s also the issue of tax deductibility. I’m no tax expert, but mortgage interest is generally 100 percent deductible. The deductibility of points, however, can be a gray area.

Some argue that an “origination fee” is not deductible, where “discount points” are considered deductible expenses. On a refinancing, however, points are only deductible over the life of the loan, allowing only a small amount each year.

If the borrower’s tax adviser concludes that mortgage interest paid is deductible and that the origination fee is not, we need to take into consideration the fact that the extra \$208 in extra interest paid each month can come off the borrower’s taxable income.

Using a modest 25 percent tax rate, the borrower saves \$52 per month in tax obligation.

The difference in monthly payment now shrinks to \$143.

Now, if we divide the true monthly savings of \$143 into the initial cost of the \$5,000 origination fee, we come up with a break even period of 35 months, or almost three years.

While three years might be a short enough period to recoup the origination fee for some folks to decide that the \$5,000 is worthwhile, there is one more very large problem with this writer’s assumptions.

In my 20-plus years in the mortgage business, I had never heard of any lender offering an interest rate “buydown” of 1/2 percent for only 1 point. Most lenders will charge 2 points per 1/2 percent drop in rate.

Since the writer works for a large bank, I decided to do a little detective work. I hopped in my car and went to the nearest branch and inquired about a mortgage.

I told the branch manager about the article I read and the fact that a 1/2 percent drop in rate at a cost of only 1 point seemed too good to be true.

Sure enough, he checked his computer, and I was quoted a fee of 2 points if I wanted to lower the interest rate on a loan by 1/2 percent.

The writer must have made a mistake, he tells me.

So the bottom line is simple: The writer’s example is incorrect.

It will cost his hypothetical borrower \$10,000, not \$5,000 in nonrefundable points to lower the note rate by 1/2 percent.

I stand by my continued advice: Stick to low-fee, no-point loans when buying a house or refinancing.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]pmcmortgage.com).