Lenders are concerned with obtaining the highest possible level of yield from any investment they make. The term "yield" means not only the rate of interest but such other economic benefits as the lender can obtain.
Suppose the current mortgage interest rate is 8.75. The same money could also be committed to short-term consumer loans or auto financing - both at higher rates than a mortgage. Fortunately, lenders seek a balance of risk, yield and time commitments.
In terms of housing the most common method to raise the yield involves the use of points paid at settlement. A "point" is equal to 1 per cent of the mortgage. If a buyer seeks a $60,000 loan and the lender requires three points, $1,800 would be due at settlement. The catch here is that a poorly designed contract may force a seller to pay part of the buyer's financing costs.
Points are commonly used with FHA and VA mortgages because the rate of interest under these programs is established by regulation rather than the market. In the example above, three points at settlement means the lender is actually providing $58,200 but has a note for $60,000 at, say, 8.5 per cent interest. In effect the rate of interest is substantially higher.
Current FHA and VA regulations state that a buyer can only pay one point. This means the seller must cover the balance, if any. Because of the points issue, some sellers refuse to sell through these programs, thus defeating the goal of greater housing availability.
Sellers should offer their homes on a each basis only. If a seller places a house on the market at $60,000 plus points, that is not the same deal. A seller may suggest a price of $61,800 with the understanding that the seller will then pay three points.
To protect themselves, sellers must maintain contact with lenders. This should be done before a house is on the market and while it is for sale. By knowing the market sellers will not obligate themselves to more than the minimum number of points on listing agreements or sales contracts.Sellers who list points above the prevailing rate may find they are committed to an unnecessary expense at settlement.
The subject of who pays how many points, if at all, is a negotiable item between the buyer and the seller. Sellers should "build in" points when establishing a price. If demand permits, and it is necessary to pay some or all at the buyer's financing, the built-in points will then become that much more profit for the seller who plans ahead.
Peter G. Miller teaches the course "How to Sell Your Own Home - With or Without a Broker" through the Consumer Information Institute here.