Q: We just don't understand why we, as sellers, have to pay points to help our buyer obtain a mortgage loan. Can you explain what a point is, and why we have to pay this?
A: Points can be best described as a legal way of avoiding usury laws. Historically, when mortgage money has tightened up but state usury laws prohibited loans over a certain percent, lend-ers have found they were able to charge points to get around these statutes.
A point (also called a discount) is one percent of the amount of the loan. Thus, if the loan is $60,000, one point would be $600.
Sellers often find that they have to pay many points (the current market is about five) where the buyer is obtaining a VA mortgage. The Veterans Administration has taken the position that all buyers are poor and all sellers are rich. Thus, the buyer is only permitted to pay one point, and the seller is thus required to pay the balance of the points needed to make the loan feaible for the lender.
Let's look at it this way. The current rate for a VA loan is 9 percent. But money is tight and it costs the lender more than 9 percent to borrow the money on the open market. Thus, no lender is willing to make mortgage loans at the VA rate, unless they can obtain a profit -- called "yield" -- for themselves.
Generally speaking, one point can be equated to an additional one-eighth percent interest on your loan. If the lender can only charge one point to the buyer, it must look to the seller for the balance of the points to raise the yield to current market levels.
While this may sound technical, the bottom line tells sellers that they will have to pay points to assist a buyer who is obtaining a VA loan. If the borrower obtains a $60,000 loan, the buyer will have to pay one point, or $600. But under current market conditions, the seller may be asked to pay up to five points, which amounts to $3,000.
Needless to say, this is a lot of money and the seller should raise the purchase price of the house to cover these points.
Sellers should inquire, before they sign a contract, what points will be charged them at settlement. It is strongly recommended that the contract for sale specifically indicate the number of points the seller is willing to pay.
In most standard real estate contracts there is a provision for the number of points which the seller will pay. This number should be filled in prior to signing any real estate contract.
There are also serious tax consequences to consider when dealing with points.
The points which the seller is required to pay to a lender as a condition for arranging financing terms for the buyer (also called "loan placement fees") are not deductible as interest. They are considered "selling expenses," however, reducing the amount realized from the sale of the property for tax purposes.
If you are buying another house of equal or greater value within a period of 18 months, you will be able to defer the profit you have made, and will not benefit immediately from this reduction.
The buyer, on the other hand, is able to deduct points paid, but only if the charge is solely interest and paid for the purchase or improvement of your principal personal residence. In this case, you will be able to deduct the point during the year in which it was paid.
The Internal Revenue Service has added a new wrinkle, namely that the deduction may not exceed the number of points generally charged in your area. I can only suggest that the taxpayer deduct the points, and let the Internal Revenue Service make its challenge, if necessary.
Benny L. Kass is a Washington attorney.