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Making a point with points

How do you figure what combination of rates and "points" add up to be the least expensive loan? How do you know whether to go for a lower rate with more points or to shop for zero points with a higher rate?

A "point" is equal to 1 percent of the mortgage amount and is payable at loan settlement. Borrowers typically pay most or all of the points levied in a transaction, but home sellers in some markets also chip in for one or more points.

What's the better deal _ a loan at 9.75 percent with 3 points or a loan at 10.5 percent and 2 points? Equally important, can loan shoppers figure out the answer by checking the benchmark they have been taught to trust _ the APR, or annual percentage rate?

Forget the APR when it comes to points. The name of the game in figuring the true cost of your points is the length of time you expect to be in the house.

Consider these examples prepared by David Hershman, vice president of American Residential Mortgage Corp., a national lender.

Take the relatively common case of a loan quote of 9.75 percent with 3 total points, 2 to the home buyer, 1 to the home seller. What's the APR on the mortgage? In the disclosure documents it says 10.1 percent, but because of the effect of the points paid up-front the true cost to the home buyer is:

A staggering APR of 22.3 percent if the buyer has a sudden change of circumstances and has to pay off the loan three months after closing.

An APR of 16.1 percent if the owner sells after six months.

APRs of 13.1 percent after one year, 11.5 at 2 years, 10.5 percent if payoff occurs in year five and 10.4 percent in year seven.

The earlier the payoff and the higher the points, the higher the true APR.

Now consider a loan with zero points. Hundreds of lenders offer these, sometimes tagging them as their "pointless" or "point-free" alternatives. Because there are no points, the APR on such mortgages doesn't change over time. If it's a 10.5 percent no-point loan at closing, the APR is 10 percent from year one to year 30.

How does a $100,000 loan at 10.5 percent with zero points stack up against the same-size loan at 9.75 percent plus 3 points described above? At the end of year one, the borrower with higher rates but no points has laid out $10,976 to the lender. The borrower with the lower rate _ but points up-front _ has already laid out $13,309 including the cash at settlement.

At the end of year two, the higher-rate, no-point borrower has paid $21,953 to the lender, while the lower-rate borrower has paid $23,619. Only at the beginning of the sixth year does the lower-rate home owner begin to "save" money in comparison with the 10.5 percent borrower.

At that point, the true APR on the 9.75 percent mortgage dips below the constant 10.5 percent APR on the point-free competitor.

Had the buyer resold the house or refinanced the loan before year six, the apparent advantage of taking out a 9.75 percent loan with a "truth-in-lending" APR of 10.1 would have proved illusory in comparison with a zero-point mortgage carrying a 10.5 percent fixed rate.

On the other hand, had the 9.75 percent borrower retained the loan for 10 years, he or she would have chosen the right mortgage. The APR would have dropped to 10.1 percent by that year, and the borrower would have saved roughly $3,700 compared with the zero-point alternative.

By the end of the full 30-year terms, the 9.75 percent borrower's savings would exceed $17,000 over the 10.5 percent loan.

The longer you stay, the less effect the up-front points will have on the APR.

Before choosing a "pointless" mortgage, ask yourself the same question. This time, though, the shorter your likely stay, the better.

Washington Post Writers Group