Mortgage points, increasingly important to everyone involved in the buying, selling, building and financing of houses, have taken on even greater significance now that interest rates have soared over 10 percent.
Points -- each one is 1 percent of the mortgage -- are paid at the time a loan is made, often by buyer and seller, to provide a market yield to the lender when the actual interest rate of the mortgage is set below the current market level.
Mortgage discount points have been used for several decades. They go back to the origin of financing by the Federal Housing and Veterans administrations. Philip N. Brownstein, a former VA loan guaranty office and FHA commissioner, recalls that there was a time when the FHA-VA rate was 4 percent and builders sold their loans on new houses above par.
In effect, they were paid points for providing mortgages that were wanted by investors seeking the security of government-backed loans.
But thrift institutions then were paying far less for savings. Now the thrifts face higher passbook rates (5 1/4 percent) and have money market certificates now paying about 10 percent to six-month investors.
As mortgage rates increased over the years and as FHA-VA rate ceilings have tended to be below the market for several decades, more discount points have been charged.
Currently, there is evidence that high points for FHA-VA loans are discouraging some sellers. At the same time, mortgage rates may be nearing their peak. Diminished buyer interest, on one hand, and avilability of investment money (particularly from insurance companies and pension funds) on the other side may level off the market.
Also, some builders are slowing down their development plans because of construction loans pegged at 11 3/4 percent, plus points. They remember being caught in the wringer in 1973, when the market tigh tened and construction loans were expensive.
Currently, mortgage interest rates are at an alltime high in most parts of the nation and in this area are at 10 1/2 to 10 3/4 percent. If the loan is conventional, with no federal guarantee or insurance, the buyer usually pays one discount point on the amount of the mortgage as an origination fee for the cost of preparing and making the loan. To get a below-market rate, however, the buyer may elect to pay additional points at settlement to lower the mortgage interest rate and the monthly payments.
Usually, the seller is asked to pay one point to increase the yield of the loan to the lender.
If the loan is FHA or VA, where the federally set ceiling is now 9 1/2 percent, the buyer by law is restricted to paying no more than one discount point Not unlike other mortgages, the FHA-VA loans are often sold by the originating lenders.
For instance, a FHA-VA loan might be arranged with a mortgage banker or thrift institution that would, in turn, sell the mortgage, along with other loans, to investors. But investors do not want to buy 9 1/2 percent loans in today's market, when others are available for 10 1/2 percent, despite the federal backing.
As a result, packages of FHA-VA and other lowerrate loans are sold at "discounts," or below par, to equalize the market yield. Now the common discount points on FHA-VA loans are set at 4 to 6, meaning that the loans can be purchased by investors for 94 to 96 percent of the face value.
The secondary mortgage market is big and complex. It is dominated by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Association and big private investors, notably insurance companies and pension funds. Mortgages are resold and resold again in this secondary market.
Home sellers have a major interest in discount points and the secondary mortgage market. And there's no restriction on the number of points a seller can pay.
This can be costly to builders who provide FHA-VA financing for new houses and to sellers of existing houses.
For instance, if the mortgage is $50,000, the builder or seller now would have to pay five points or $2,500 at settlement. If the resale house is priced at $60,000 and a 6 percent real estate commission is paid, then the seller would be paying a $3,100 commission, or a total of $6,100 from his or her proceeds at settlement.
Unless there are investors out there waiting to buy already made mortgages, the availability of new funds tends to become constricted. Even in the conventional loan market, which now is dominated by savings and loan institutions, the S&L making the loan to a buyer often has in mind reselling the loan to an investor to create new funds with which to make more loans.
In recent months, mortgage bankers and some others in the real estate industry have contended that the discount points for FHA-VA loans have become too high. They argue that sellers will accept two or three points but that they tend to avoid FHA-VA financing if points range above four.
In today's high mortgage rate market, FHA-VA loans are most attractive to buyers. Yet most buyers are now aware that sellers who are going the FHA-VA route also tend to price their houses higher to overcome the penalty of paying high discount points.
Meanwhile, the Secretary of Housing and Urban Development, who sets the FHA ceiling (which is traditionally endorsed by the VA), has seen fit to keep the ceiling at 9 1/2 percent. The reasoning is that it will hold the line on mortgage costs and set a national pace for rates. It also is part of the Carter administration game plan to fight inflation. Interest rates are a factor in determining the rise and fall of the cost of living index.
Builders of new houses offering FHA-VA financing are accustomed to paying points to obtain those loans for buyers. And, in recent years, large-volume builders also have been buying conventional mortgages for their buyers. This is done by contracting, in advance of selling, with lenders for permanent mortgages at a rate that is expected to be slightly below market. Then the lower rate is used as a sales tool.
Of course, the cost of that financing to the builder is added into the price of the house. The theory is that the lower interest rate enables more prospective buyers to qualify (be eligible financially) for loans. But this practice is also inflationary, adding to the cost of the house.
Realty executives such as William C. Stuart III and Thomas Shafran contend that mortgage discount points are a fact of business life. As Shafran sees it, mortgage points paid by sellers for FHA-VA loans enable more potential buyers to be available for possible purchases, thus increasing the marketability of a house. Stuart contends that lack of conventinal mortgage money has handicapped Marylanders wanting to sell or buy under the 10 percent usury ceiling that is expected to be adjusted soon by the legislature.
"Mean while there's FHA and VA in an unreal market. Points generate new investing funds and even help keep ratres down," Stuart said.
But former Mortgage Bankers Association executive Oliver H. Jones says, "It's a lousy system." He observed that the total points charged can amount to more than just an adjustment to normal market yield.
"Points can cause an unnecessary distortion in market and pressure prices to be increased, with the buyer sometimes paying more than would be paid if the actual market rate was the basis of the loan," Jones said.
If the buyer sells early, within two or three years afer buying, the mortgage lender tends to benefit because of the points paid up front.