Loan Points Mortgage Lending Practices...
Mortgage loan points which
is a term in real
estate finance that
causes much
confusion. In
finance, the word
point means one
percent of the loan
amount. Thus, on a
$60,000 loan, one
point is $600. On
a $40,000 loan,
three points is
$1,200. On a
$100,000 loan, eight
points is $8,000.
The use of points
in real estate
mortgage finance can
be split into two
categories: (1) loan
origination fees
expressed in terms
of points and (2)
the use of points to
change the effective
yield of a mortgage
loan to a lender.
Let us look at these
two uses in more
detail.
Origination
Fee
When a borrower
asks for a mortgage
loan, the lender
incurs a number of
expenses, including
such things as the
time its loan
officer spends
interviewing the
borrower, office
overhead, the
purchase and review
of credit reports on
the borrower, an
on-site appraisal of
the property to be
pledged, title
searches and review,
legal and recording
fees, and so
on. For these, some
lenders make an
itemized billing,
charging so many
dollars for the
appraisal, credit
report, title
search, and so on.
The total becomes
the loan origination
fee, which the
borrower pays to get
his loan. Other
lenders do not make
an itemized bill,
but instead simply
state the
origination fee in
terms of a
percentage of the
mortgage loan amount, for
example, one point.
Thus, a lender
quoting a loan
origination fee of
one point is saying
that, for a $65,000
loan, its fee to
originate the loan
will be $650.
Discount
Points
Points charged to
raise the lender's
monetary return on a
mortgage loan are known as
discount points. A
simplified example
will illustrate
their use and
effect. If you are a
lender and agree to
make a term loan of
$100 to a borrower
for 1 year at 10%
interest, you would
normally expect to
give the borrower
$100 now (disregard
loan origination
fees for a moment),
and 1 year later the
borrower would give
you $110. In
percentage terms,
the effective yield
on your loan is 10%
per annum (year)
because you received
$10 for your 1-year,
$100 loan. Now
suppose that,
instead of handing
the borrower $100,
you handed him $99
but still required
him to repay $100
plus $10 in interest
at the end of the
year. This is a
charge of one point
($1 in this case),
and the borrower
paid it out of his
loan funds. The
effect of this
financial maneuver
is to raise the
effective yield
(yield to maturity)
to you without
raising the interest
rate itself.
Therefore, if you
loan out $99 and
receive $110 at the
end of the year, you
effectively have a
return of $11 for a
$99 loan. This gives
you an effective
yield of $11 divided
by $99 or 11.1%,
rather than 10%.
Calculating the
effective yield on a
discounted 20 or 30 year mortgage
loan is more
difficult because
the amount owed
drops over the life
of the loan, and
because the majority
are paid in full
ahead of schedule
due to refinancing.
However, a useful
rule of thumb states
that on the typical
home loan each point
of discount raises
the effective yield
by 1/8 of 1%. Thus,
four discount points
would raise the
effective yield by
approximately 1/2 of
1% and eight points
would raise it by
1%. Discount points
are most often
charged during
periods of tight
money, that is, when
mortgage money is in
short supply. During
periods of loose
money, when lenders
have adequate funds
to lend and are
actively seeking
borrowers, discount
points
disappear.
Rate Ceilings
The use of
discount points is
an important part of
FHA and VA loans,
because the FHA and
VA set interest-rate
ceilings on loans
they insure or
guarantee. With only
two exceptions since
1950, the FHA and VA
ceilings have been
below the prevailing
rates on
conventional loans
(non-FHA or non-VA
loans). Thus, if the
prevailing
open-market interest
rate on conventional
loans is 10-1/2% and
the FHA and VA
ceilings are at 10%,
a borrower will not
be able to obtain an
FHA or VA loan
without offering the
lender enough
discount points to
raise the effective
yield to 10-1/2%. If
conventional loans
can be made at
10-1/2% interest, it
is illogical for the
lender to accept
10%. To obtain a 10%
loan, the borrower
must pay the lender
four discount
points.
However, the VA
limits the number of
points that the
borrower is allowed
to pay to 1 point
for existing homes
and 2 1/2 points for
homes under
construction, and
these are usually
consumed by loan
origination costs.
These are called
borrower's points or
service points.
Any additional
points charged by
the lender must be
paid by someone
other than the
buyer. That usually
means the seller.
For example, on a
$60,000 loan, when
the market rate is
1/2% above the VA
ceiling, this
amounts to $2,400 in
seller's points. In
other words, out of
the proceeds from
the sale, the seller
would have to pay
the lender $2,400 so
the buyer could
enjoy the privilege
of obtaining a loan
with an interest
rate 1/2% below the
market.
By placing
yourself in the
seller's position,
you can see the
situation this
creates. A buyer
making an offer
under the above
conditions is in
effect asking you to
take a $2,400 cut in
price. If you were
planning on reducing
your price $2,400
anyway, you would
accept the offer.
However, if you felt
you could readily
sell at your price
to a buyer not
requiring seller's
points, you would
refuse the offer.
The alternative is
to price the
property high enough
to allow for
anticipated points.
However, this is an
effective solution
only if your price
does not exceed the
VA certificate of
reasonable value. If
it does, the VA
buyer is either
prohibited from
buying or must make
a larger cash down
payment. One reason
for the success of
private mortgage
insurers is that
they impose no
restrictions on
either interest
rates or discount
points.
Mortgage
Loan
Points To Home
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