A Note on a Borrower’s Optimum Choice of Points and Mortgage Interest

Abstract

In their seminal paper on mortgage points and taxes, Kau and Keenan (1987) consider a borrower and a mortgage lender with constant tax rates of t and u, respectively. The lender offers the borrower combinations of mortgage discount points and interest rate that yields the lender the after-tax market rate. Assuming the points and interest are tax-deductible for borrower and taxable for lender, Kau and Keenan conjectured that: if t = u, borrowers choose zero points, while if t > u, the borrower chooses the highest number of points. We provide a proof of this conjecture.