Points and The Tax Effective Payment

I know what you're thinking, "Chaz, what in the world is the Tax Effective Payment???  I've never heard of that before!"

Well, the Tax Effective Payment is a critical tool used in helping your borrowers determine how many points to pay, a decision which is just as critical to you and your customer.  So how do you help the borrower determine how many points is appropriate for their situation.  There is a system and it's something you may not know to help them determine the best course of action. 

Here's a scenario:

Applicant applies and is approved for a conforming product.  The days best published rate is 6.25% at par.

• Purchase price:  $250,000
• Loan amount (95% LTV):  $237,500.00
• Term:  30 Year Fixed
• P&I:  $1,462
• Interest:  $1,237
• Principal:  $225

_{*Please note that cents have been excluded from all monetary examples for simplicity in demonstration.} 

So what is the best course of action for the borrower?  You the trusted mortgage professional can offer them guidance in their decision.   Guidance that sets you apart from the competition...something no one else is telling them!  Here's how!

The first thing to consider is what is the borrower's average tax liability?  Want to find out?  Go here:  Tax Liability Calculator

Let's assume for this scenario that the borrower has the average tax liability of 25%. 

Each year for the first 15 years in the example above (all factors for 30 year amortization considered and remain) the customer will pay $14,844 in interest at a 25% tax liability this will yield the borrower $3,711 a year in tax benefit from the interest paid.  This translates to a tax benefit of $309 per month or a Tax Effective Mortgage Payment of $1153 per month at the end of a full tax year. 

Let's say that the borrower is trying to decide between par and paying 1 point or even 2 points. 

Let's show them the math:

Here are the buy-down options:

0.0 points - 6.250%                    0.5 points - 6.000%                    1.0 points - 5.750%

                        1.5 points - 5.625%                    2.0 points - 5.500%

Now here's the math:

1. Compute the monthly payment and interest only payment.
2. Interest * 12 months = Annual Tax Deductible Interest
3. Annual Tax Deductible Interest * Tax Liability = Annual Tax Benefit Savings
4. Annual Tax Benefit Savings / 12 months = Monthly Tax Benefit Savings
5. Monthly P&I - Monthly Tax Benefit Savings = Annualized Tax Effective Payment per month
6. Finally compute the difference in the Tax Effective payment per month and the cost of the points (just like you've probably done with the difference in the payments on buy-down versus par but this demonstrates the full effect).

Payment at 1 point or 5.750% = $1386 with interest of $1138

$1138 * 12 = $13656 - Annual Tax Deductible Interest

$13656 * 25% = $3414 - Annual Tax Benefit Savings

$3414 / 12 = $284 - Monthly Tax Benefit Savings

$1386 - $284 = $1102 = Annualized Tax Effective Payment per month

Payment @ par is $1462 minus payment at 1 discount point $1386 a savings of $76 per month. 

Monthly Tax Benefits Savings of $309 @ par minus Monthly Tax Benefits Savings of $284 @ 1 point equals a loss of $25 dollars per month. 

Actual savings per month for this scenario = $51

1 points or $2,375 in immediate closing costs saves $51 per month and will take 46 months to recover. 

Now that we know how long it will take to actually recover the costs here are the things we should consider and ask the borrower:

1. Who is paying for the buy-down?  The borrower or the seller?
2. How long does the borrower truly intend to stay in the home?

The answers to these questions will help you determine how to advise your customers on what is the best course of action. 

Ready to try it?  Computing the benefit/cost of spending 2 points and see what you determine and you can comment on what advise you would offer clients!

I hope you find this tool as useful and exciting as I have.  Remember it's not what we do that sets us apart from the competition...it's How we do it!

Chaz Ramirez is a DE Underwriter, HUD Title II Mortgage Application Consultant, and a Trainer.  For more information about me and my services please visit my ActiveRain profile.