
Subject: Re: Refinancing without paying points? Date: 5/7/2001 4:41 AM
Recommendations: 11
Hi Spinning,

I had printed out your questions to answer later, got swamped, and only 'rediscovered' the questions tonight (this morning?)

Anyway, here they are;

If you have the cash to pay points, you also could use the cash to increase the downpayment and lower the principle. What are the advantages and disadvantages of this?</i?

Well, your cash has some kind of opportunity costs to it. If you spend it on either points or closing costs, you can't spend it on your lady, or at Vegas, or a new Jetski, or whatever. This is no secret, but always good to remember.

If you pay cash for down payment, you've made that cash illiquid, expensive to free up again, slow in appreciation... but you've saved yourself from paying interest (however that interest rate you've avoided will be the lowest real after-tax interest rate you'll ever see on that money.)

If you use that cash to buy down interest by paying points, you've effectively used a small amount of cash to future-leverage yourself by eliminating a significant, disproportionate amount of mortgage interest. Every dollar of buydown points will eliminate approximately $10 of lifetime loan interest. The return-on-investment on each dollar spent on points is an effective 30-35%, and there's no capital gains tax issues triggered. Now THAT's "Foolish."

This definitely makes incredible sense if;
A) you know you'll be in the loan long enough the ROI pays off the cost of the investment itself (the points,) and,
B) you've got the cash to invest.

I looked at the payments based on your table of rates and points and the payments were lower if you paid more points and increased the principle accordingly. So, if you keep the loan 30 years, paying points is better than a bigger downpayment. Is this generally true or does it change as the rate table changes?

You are completely correct, and YES, it is generally true in all discountable loan scenarios.

Rayvt points out (in one of his contradictory rants) that the lenders price discounts and rebates on loans in perfect efficiency with the markets... and this is true... meaning that there theoretically is no advantage to be wrung out of this... EXCEPT that Rayvt ignores that this scenario is pegged to a specific time frame. IF you fall into the "average borrower's category" which is;
A) Thinks you're moving in forever, but,
B) refi's or moves within 3-5 years...

The the lender wins if you take the discount points bet.

However, if you do indeed stay longer than 3-5 years, you get a pre-paid, risk free ROI that is unheard of in even the biggest of NASDAQ Bull markets... and it's already a done deal... it's locked into your loan contract... it's guaranteed! Doesn't get better than that!

If you pay off the loan early, then the higher original principle means you owe more at payoff. Is there a rule of thumb for determining the breakeven point?

It's a 10-1 payoff on cash, with a 3-5 year time-drop. In other words, your Points dollars either cost, or pay, 30-35% annually from loan inception (depending on which way you structure the loan.) With that in mind, it almost seems insane that most folks not only avoid paying points, but insist the reverse occurs by having the lenders pay the cloisng costs!

Another way to think about it is this. What if, in addition to paying points, increasing the principle, and thus lowering the payments, you made the same payments as the par loan. How long until your remaining principle is less than on the par loan?

It depends on the amounts in your example, but not rocket science to figure out. All you need is an amortization table. It's amazing how quickly it pays off.

Also, suppose you were thinking of a downpayment well above 20%. Is there a maximum number of points you can pay? Do you still get the above advantage with 5, 10, etc. points?

There is a maximum in each scenario. Obviously, without any limits you could theoretically buy down a loan to zero interest rate... or even theoretically negative interest, meaning the bank pays YOU to borrow their money. While attractive, it doesn't fly unless you're a communist/socialist government (they always seem to convince folks of the dream of a free life from pennies from heaven!)

In a best case scenario, a borrower would simply borrow the maximum Loan-To-Value possible, and pay the maximum discount to get the lowest possible rate on his money. He would then take his liquid capital and employ it where he gets significantly better rates of return than the costs. Again, not rocket-science when viewed from the clear, larger perspective... but people dig in and get all confuddled with the minutea, they forget to use a higher level of common-sense.

Of course, some could jump in and say "Dave's just another loan broker looking to make a bigger commission by talking people into borrowing more money." Totally false! Talking people into loans that don't make sense is the best way to guarantee no referrals or return business. Folks ALWAYS figure out what happened to them EVENTUALLY. In my case, if they didn't at first understand, I want them to eventually get their "Ah HA!" and realize I had tried to steer them right in the first place.

The truth is I offer what I see as intelligent... and I serve my clients however they ask me to. Sometimes that means doing what I think is dumb... but ultimately I'm not paid for making decisions FOR them, just getting the deal done as professionally as possible.

Thanks for the questions! If you found the answers helpful, hit 'reco' so others might see it (since the string is so outdated by now.)

Dave Donhoff
Lic. Mortgage Broker
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