This is a win-win scenario, unfortunately both wins are for the Lender. The Lender achieved two objectives;

Firstly, the Lender got you to sign for 5 years because a $3000 cash back sounds and appears a lot better than lowering the rate from 8.25 down to 7.453, in fact some Lenders will give you up to .75 percent points off the published rates just for asking, especially if you have other business with them (investment vehicles such as Mutual Funds).

Secondly, the Lender has you locked in for 60 months at a rate of 8.25%. If you do decide to payout out the mortgage before the term is over (because rates are dropping) your penalty is based upon the interest rate differential. For example, if after one year, the 4 year term rates are 7 % then the differential is is 1.25 (8.25-7.0) where as if the rate would have been 7.453 the differential would have been 0.453 (7.453-7.0). The larger the differential the larger your IRD “penalty”.

Buyer beware! Things are not always what they seem to be.

ALTERNATIVE VIEWPOINT BELOW: Another way of looking at this example is to view it as a DISCOUNTING example. A $100,000 mortgage at 7.453% with a 5 year term.

QUESTION: What price does one have to pay to purchase the mortgage and receive an 8.25% “yield” rather than the 7.453% “yield” over the next 60 months.

ANSWER: $97,000 (see B below in the DISCOUNTING program)