December 11, 2000, Revised August 28, 2007
"My income recently doubled, but I'm having trouble getting up the cash
I need for the house I want. A friend recently suggested that I look for
a negative point loan on which the lender would pay me points. Is this
on the level and where do I find it?"
Negative Point Loans Are Available From Most Loan Providers
Yes, negative point loans (also called "rebates" and "yield spread
premiums") are on the level, but they are not necessarily a good buy for
a cash-short borrower like you. If you do elect to take a negative point
loan, furthermore, you will be hard pressed to find one at reasonable
terms in shopping conventional channels.
The best place to find them is from an Upfront Mortgage Lender (UML),
because they display all the rate/point combinations they offer on the
screen. For example, on August 28, 2007 Amerisave (a UML) displayed 12
rate/point combinations on 30-year fixed-rate mortgages covering
single-family homes purchased for occupancy in California. Three were
negative point offers.
Alternatively, you can request a negative point loan from an
Upfront Mortgage Broker (UMB). Because UMBs set their fee in
advance, they don't view negative point loans as an invitation to
increase their own income from the deal, which many other brokers do.
Legitimate Uses of Negative Points
Negative points must be used to defray the borrower's settlement costs.
They cannot be used to pay any part of the down payment. For this
reason, you do not want to select a rate/point combination that has
negative points in excess of your settlement costs. For example, if your
total settlement costs on a $100,000 loan is $2,500, negative 2.5 points
would just cover it. If you took a negative 3 point loan, you would be
leaving $500 on the table.
Borrowers Who Should Select Negative Point Loans
Two categories of borrowers gravitate toward negative point loans.
Borrowers with short time horizons like them because they will not be
paying the high interest rate for very long. For such borrowers,
negative point loans can be a good buy.
The second category, into which you fall, consists of borrowers who are
short on cash. If they have a long time horizon, however, negative point
loans are a bad buy because they are priced for borrowers with short
horizons. In this situation, they are a costly necessity.
Getting a Fair Deal
The other problem is finding a negative point loan without being
fleeced. The problem is that, off the web, lenders provide price
information on negative point loans to independent mortgage brokers and
to their own loan officer employees, but not to consumers. Many loan
officers and mortgage brokers view negative point loans as an
opportunity for a larger markup or commission.
In a study I did a while ago, I found that the markups earned by
mortgage brokers were persistently higher on negative point loans than
on positive point loans. For example, on a loan on which the quote by
the wholesale lender was 6% and 2 points, the deal to the borrower might
be 6% and 3 points, or a markup of 1 point. On a loan on which the quote
by the wholesale lender was 7% and -2.375 points, the price to the
borrower might be 7% and zero points -- a markup of 2.375 points.
Why is this? Borrowers do not have the information they need to protect
themselves, and their resistance to paying higher rates is lower than
their resistance to paying more points.
Inadequate disclosure rules are a contributing factor. The mortgage
broker in the first case above would record a Mortgage Broker Fee of 1
point on the Good Faith Estimate of Disclosure provided to the borrower,
while in the second case the Mortgage Broker Fee would be shown as zero!
The rationale for this rule, which is totally absurd, is that the fee in
the second case is being paid by the lender rather than by the borrower.
But even if the disclosure rules applicable to mortgage brokers were
fixed, it won't help consumers dealing directly with lenders because
loan officer employees of lenders who overcharge for negative point
loans leave no tracks. This is why mortgage brokers view having to
disclose their charges as unfair.
The Government is not going to solve this problem anytime soon.
Meanwhile, borrowers can protect themselves by dealing with
Upfront Mortgage Brokers, who charge a fee for their services and
pass along the negative point quotes they get from lenders.