FHA AND VA MORTGAGE DISCOUNT POINTS AND HOUSING PRICES

Abstract

ONE OF THE MOST DEBATED ISSUES in mortage lending is whether buyers or sellers pay discount points charged by lenders when FHA insured or VA guaranteed mortgage are used to finance housing purchases. Discount points are charged by lenders making FHA and VA mortgage loans for two reasons: first, contract interest rates on these loans are regulated' and tend to lag behind conventional interest rates, and second, loan origination fees on these mortgages are limited to a fixed proportion of the amount loaned, which may or may not be adequate to cover actual loan origination costs.2 As a result, at any point in time, discount points charged by mortgage lenders tend to make effective yields on FHA and VA mortgages equal to yields on conventional mortgages with the same loan terms, risk and servicing costs. There is no question that lenders charge discount points, when required, to earn a competitive yield on amounts loaned. However, the controversy over their use stems from FHA regulations prohibiting lenders from collecting discount points from borrowers who are purchasing property. In effect, these regulations result in sellers, not buyers of property, paying discount points to lenders. The rationale for such a regulation can be best summed up by the stated purpose of the FHA insurance program, ... . to encourage improvements in housing standards and conditions, to facilitate sound home financing on and to exert a stabilizing influence in the mortgage market.3 Such a purpose seems implicitly to assume that buyers seeking financing with an FHA or VA mortgage will be charged the regulated contract interest rate and that sellers will absorb part of the financing costs incurred by buyers, since sellers must pay discount points. Ostensibly, this would allow the homebuyer to obtain reasonable terms while keeping the regulated contract rate stable.4