Points Raise the Cost of a Mortgage

QUESTION: My wife and I are seriously considering buying a house, so we have been watching the newspaper ads to see what interest rate we’re likely to have to pay. We’re both puzzled over the term points that we keep coming across. The best rate we’ve seen for the size and type of loan we would need is 9%, but there is a notation after the rate that the S&L; also tacks on three points. What are these points, and how do they affect the total price of a mortgage?--B. M.

ANSWER: A point is the equivalent of 1% of the amount of the loan and must be paid by the borrower, in cash, when the loan closes. In other words, these seeming afterthoughts in the ads can add up to sizable chunks of money--especially since lenders are currently commanding between two and four points on conventional 30-year fixed-rate mortgage loans.

Using points, lenders can effectively raise the price they charge borrowers for a home loan without actually increasing the mortgage rate--the number that home buyers are most apt to inquire about when they’re comparison shopping.

Knowing what points are doesn’t help you much, though, in analyzing whether a 9% loan with three points is a better deal than a 9.5% loan with one point.

As a rule of thumb, figure that each point will add about one-quarter of a percentage point to the cost of your loan. So, the two loans are about equal--both being the equivalent of a 9.75% loan with no points.

To be more accurate, however, you have to consider how long you intend to stay in the house. Generally speaking, if you plan to keep paying on the mortgage for only a few years, you’re better off taking a loan with a marginally higher interest rate and paying fewer points. That’s because you won’t have enough time to make up, through the lower monthly payment, the large sum of cash you had to lay out up front.

But if you intend to keep the house and the loan for 10 years or more, you’ll want to seriously consider locking in the cheapest rate you can find.

According to the Mortgage Bankers Assn., a lender that tacks three points onto a 9% mortgage loan is really charging 10.18% if the borrower keeps the loan for only three years. But if the borrower keeps paying on that same loan for 10 years, the equivalent rate is 9.48%.

If you could find a 9% mortgage carrying just one point, the association says, the equivalent rate is 9.39% if you keep it only three years and 9.16% if you stay in the house for 10 years.

Of course, even the best advice is pointless if you just don’t have the money to make a down payment on the house and pay points as well.

Q: All the news about the tip that led government investigators to investment banker Dennis B. Levine and other inside traders has made me curious about how much the IRS relies on tipsters to catch tax cheats. Does the agency have a sophisticated computer system of its own that catches cheaters or does it, like the SEC, depend on tipsters?--D. T.

A: Both federal agencies make use of sophisticated computerized detection systems as well as tipsters to catch cheaters. But the IRS says its computer provides far more useful leads than tipsters do.

The vast majority of tips, in fact, turn out to be frivolous, the IRS says. For example, in fiscal year 1985, the last year for which data is available, only 596 of the more than 10,000 tips received by the IRS led federal agents to consumers or businessmen who had underpaid their taxes.

Those tips allowed the IRS to recover an additional $49 million in taxes that year, only about 5% of the total recovered by the agency through various means.

In exchange for their help, however, the IRS paid the tipsters $1.7 million collectively.