A new proposal floating around Washington could require lenders to make a no-point, no-fee loan option available to prospective borrowers. This so-called “zero-zero” plan would not be the only pricing lenders could offer, instead it would be one choice of many lenders could offer under a proposal from the Consumer Financial Protection Bureau.
The purpose of the zero-zero proposal is make loans easier to compare. For example, today you might see a loan at 3.5 percent and 1 point or 3.625 percent and no points. Which is the better loan?
A “point” is equal to one percent of the loan amount. If we have a $100,000 mortgage a point will cost a borrower $1,000 at closing. Since the lender is getting $1,000 up front and making a $100,000 loan, the effective interest rate in this example is 3.581 percent.
Why? With a $100,000 loan at 3.5 percent the monthly payment for principal and interest is $449.04 over 30 years. However, if $1,000 is paid up front then the initial debt is $100,000 but the amount advanced is really $99,000. If the monthly cost for a $99,000 loan is $449.04 then the interest rate is 3.581 percent over 30 years.
And the cost for a $100,000 mortgage at 3.625 percent over 30 years? That would be $456.05 for principal and interest.
In other words, paying points can make sense for some borrowers — those with cash who expect to be long-term property owners and will stick with a single loan. However, many borrowers will do better with a higher rate and no points regardless of whether they’re using FHA mortgages, VA loans or conventional mortgages.
Points & Taxes
To make the points issue a little more complex one has to consider taxes.
According to the IRS, points — also called loan origination fees, maximum loan charges, loan discount, or discount points — may be fully deductible in the year paid, may be deductible over a period of years with refinancing and in some cases with a home sale may actually be deductible by both the seller and the buyer. For details, speak with a tax professional — and bring aspirin.
True Rate Comparisons
If the CFPB proposal goes through lenders will have to offer a zero-zero alternative for most borrowers, meaning that the offered rate will have to reflect all points and loan fees. This rate might seem “higher” than today’s rates but actually the comparison is not apples-to-apples — the right comparison is a zero-zero interest level versus the rates you see today plus points and loan fees.
The argument is made that zero-zero loan rates will “force up” mortgage rates but nothing has changed about the loan except that pricing will be easier to see and understand. That would help some people avoid foreclosures and short sales and make the lending system less risky — things that should be encouraged.