What s The Point? An After-Tax Analysis of Negative Mortgage Points

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1 What s The Point? An After-Tax Analysis of Negative Mortgage Points Matthew A. Stallings Kenneth W. Monfort College of Business University of Northern Colorado Campus Box 128 Greeley, Colorado [email protected] Richard Newmark, Ph.D.* Associate Professor of Accounting Kenneth W. Monfort College of Business University of Northern Colorado Campus Box 128 Greeley, CO [email protected] and Cris de la Torre, Ph.D., J.D. Associate Professor of Finance Kenneth W. Monfort College of Business University of Northern Colorado Campus Box 128 Greeley, Colorado [email protected] * Contact Author

2 What s The Point? An After-Tax Analysis of Negative Mortgage Points Abstract Frequently, mortgage buyers are given the choice to buy down a mortgage interest rate through the use of conventional discount points, producing a lower monthly interest payment and a well understood tax treatment. Conversely, mortgage buyers may also agree to pay a higherthan-par interest rate and receive negative points; this receipt of up-front cash is commonly referred to as a yield spread premium (YSP) or rebate. This transaction is much less documented from a tax authority perspective and as such, this article looks at the transaction from a plausible tax context, and hypothesizes reasons why the IRS has not provided authoritative guidance for the tax treatment of negative points. I. BACKGROUND The vast array of options facing today s mortgage buyers leaves many individuals questioning the appropriateness of their decisions. These options include choosing between different loan maturities and deciding between fixed or adjustable interest rate mortgages. Moreover, the consumer must decide whether to buy down a mortgage interest rate through the use of discount points or to accept a higher-than-par rate of interest in exchange for a front-end payment from the lender negative points. Positive mortgage points, or simply points, are a payment made by the borrower to the lender upon loan closing. One mortgage point is equal to one percent of the total loan amount, and the payment of these points will generally lower the interest rate. Alternatively, negative mortgage points, or yield spread premium (YSP), are a payment made by the lender to the borrower upon loan closing. Again, one negative point is equal to one percent of the total loan amount and the receipt of these points will generally raise the interest rate. Negative mortgage points are used to alleviate closing costs and are not allowed for use in covering any portion of 1

3 2 the down payment. The use of negative points appears to be most valuable to a borrower who does not plan on keeping the property for a long period of time. Consequently, the borrower benefits from up-front assistance on settlement costs while only paying a higher interest rate for a short period of time. This is the crux of understanding points and negative points. In order for a consumer to determine whether paying or receiving points is the best option, one needs to understand the cash flow and tax consequences of both positive and negative points. Because of the large sums of money involved with mortgages, a proper, yet simple, analysis cannot be overstated. Given that the cash flow and tax consequences of paying positive points are already well documented, the purpose of this article is to provide a detailed discussion and analysis of negative mortgage points, particularly the tax treatment of these often misunderstood rebates. A. Positive and Negative Points When the Real Estate Settlement and Procedures Act (RESPA) was enacted in the midseventies, most residential mortgages were originated, funded, and held by banks, savings and loans, and to a lesser degree, mortgage bankers. The growth of the Federal National Mortgage Association ( Fannie Mae, FNMA) and the Government National Mortgage Association ( Ginnie Mae, GNMA) led to the subsequent development of the secondary mortgage market, substantially changing the landscape by allowing these functions to be separated and performed by different entities. In particular, the origination function is now performed by retail mortgage brokers in many cases. 1 As part of the origination function, the mortgage broker usually initiates the loan application, credit report, property appraisal, property survey, verification of employment, verification of bank deposits, and counsels to clients on available loan types. The broker

4 3 processes the information and sends it to the lender, who actually funds the loan, to review and make a final credit decision. If a borrower contracts directly with the lender, the borrower must compensate the lender for performing the origination function; if they contract indirectly through a mortgage broker, they must compensate the mortgage broker for performing the origination function. The most common form of broker compensation is an origination fee paid by the borrower at closing (e.g., 1% of the loan amount). These types of fees are typically paid directly by the borrower at settlement, and appear on the Good Faith Estimate (GFE) and Housing and Urban Development (HUD-1) Settlement Statement. However, many brokers may also receive indirect compensation paid by the lender, in the form of a yield spread premium, or negative points. The yield spread premium is nothing more than a contractual arrangement whereby the borrower agrees to pay a higher than par rate for the life of the loan, in exchange for a present lump sum, commonly expressed as a point value of the loan amount. These points can result in payments to the borrower or, in many cases, payments to the mortgage broker. The payment of points and the receipt of negative points are really mirror images of one another. Whereas the payment of points allows the borrower to buy down the rate, the receipt of negative points provides the borrower compensation for paying a higher interest rate than is required. If the borrower believes he or she will move in the short-term or that interest rates will increase, then receiving negative points may be a relatively good decision. The asymmetric nature of the positive and negative points should be noted. Examining Exhibit 1, the positive point amount to buy down a rate is greater, i.e points for a 0.25 reduction in the interest rate, than the equivalent 1.0 negative point payment received for the same 0.25 increase in the mortgage interest rate. What this implies is that the lender is willing to bid only so much,

5 4 while asking a higher present value amount for the privilege of paying a lower interest rate, analogous to the bid-asked spread prevalent in most transactions. Yield spread premiums do have legitimate uses for some cash-strapped homebuyers. Rather than paying closing costs up-front, which include broker compensation such as origination fees, appraisals, and other prepayments, these expenditures can be financed over the loan s term via a higher contract rate of interest. Quite often the lender pays the mortgage broker s compensation at closing through a YSP, and then recovers this cost over time from the borrower by receiving a loan with a slightly higher interest rate. Financing options and products such as no fee, no point loans depend on the feasibility of the YSP to compensate the loan officer for their services; in turn, the borrower does not have to pay this cost out of pocket at closing, allowing them to purchase or refinance a home with a lower initial cash outlay. Homeowners may also reduce their initial cash outlay by adding the closing fees to the principal balance of the mortgage loan. However, this approach may not be available if the borrower s loan-to-value ratio has already reached the maximum permitted by the lender. YSPs may also be a favorable financing option for borrowers that expect to refinance or move in the near term. For these individuals, the disadvantage of a slightly higher contract rate (and hence slightly higher monthly payment), is outweighed by the sharp reduction in up-front closing costs. Clearly, the benefit of using a YSP is greatest for very short-term loans, or for buyers who move or refinance every few years. Yield spread premiums are not necessarily used in all cases to lower the borrower s upfront closing costs. Some brokers or lenders who have been compensated by reasonable loan origination fees and other direct payments also receive the YSP in addition to the borrower-paid origination fee. 2 Many borrowers do not consent to or even realize they are paying a YSP via a

6 5 higher contract interest rate. Even though RESPA requires disclosure of all compensation paid to lenders and mortgage brokers as part of the settlement transaction, the manner in which the YSP is disclosed is obscure. While direct compensation (e.g. processing fees, origination fees, discount points) is included in the GFE and HUD-1 with the borrower s total settlement costs, the YSP is shown in the margin and denoted P.O.C. (paid out of closing), and is not added in the borrower s total settlement costs. This notation system is easily missed, or misunderstood by many borrowers. To further complicate matters, RESPA does not require disclosure of fees paid in secondary market transactions. Mortgage bankers, credit unions and thrifts, as well as mortgage brokers that fund loans with their own funds or use a warehouse line of credit, are not required to disclose compensation they might receive from the subsequent sale of mortgage loans in the secondary market. 3 This markup is considered part of the lenders internal record-keeping, leaving a substantial segment of the mortgage industry under no obligation to disclose YSPs at all. Most mortgage buyers need to understand that the best protection against unknowingly paying a YSP is to ask for the wholesale rate sheet. Once the consumer has this information, it is still up to the consumer to ask how the YSP will be distributed and why. Even though many brokers will argue that information is proprietary, there are more than enough lending professionals that are willing to share this information that consumers should shop for a broker that is willing to be upfront with their fees. 4

7 6 B. Why Are Mortgage Points Useful? Individuals may choose to buy down their mortgage interest rate for a variety of reasons. Some rationales may be psychological such as the perception of paying less interest over the life of the loan, while others may reflect the individual s anticipated time in the home or their current financial situation. In contrast, lender-paid points have received far less attention. Cash-short consumers can use this financing option to pay origination fees, closing costs, or even receive cash at closing. Borrowers with higher risk profiles are subject to more expensive rates. For example, if the loan is a FNMA interest-only first mortgage with a loan to value of greater than 90%, the lender will require a payment of 25 basis points. Thus, a borrower would get the listed rate if none of the conforming adjustments apply. C. Tax Treatment of Home Mortgage Interest Home mortgage interest expense is generally deductible on a taxpayer s primary residence as well as one additional residence (IRC 163(h)(4)(A) and IRS Publication 936). The qualified residence interest deduction may be limited by the amount of home acquisition indebtedness amounts used directly to acquire, construct, and/or improve a residence (IRC 163(h)(3)(B)(ii) and IRS Publication 936). A taxpayer may deduct home mortgage interest on home acquisition indebtedness, not to exceed $1 million, plus the taxpayer may deduct additional interest expense on up to $100,000 of home equity indebtedness (IRC 163(h)(3)(C)(ii) and IRS Publication 936). II. TAX TREATMENT OF INTEREST AND POSITIVE POINTS The tax treatment of prepaid interest in the form of positive points is directly addressed in the Code and other authoritative pronouncements that have been promulgated over the years to

8 7 clarify the tax treatment of common issues and most not-so-common issues related to home mortgage points. Points are currently deductible in the year paid if they are paid in connection to initial qualified home acquisition indebtedness on one s principal residence only (IRC 461(g)(2) and IRS Publication 936). Points related to qualified home acquisition indebtedness on a second residence and points related to refinancing any qualified home acquisition indebtedness must be amortized using the straight-line method over the life of the loan (IRC 461(g)(1) and 162(h)(3)(C)). If the loan ends early, any unamortized points are deducted in the year the loan ends. However, if the loan is refinanced with the same lender, the remaining unamortized points from the initial mortgage are then deductible over the life of the new loan (IRC 163(h)(3)(C)(ii)). III. TAX TREATMENT OF NEGATIVE POINTS A. Background In situations where a mortgage banker initiates a loan, there is no YSP at the time of closing because the difference between the contracted rate and the rate for which the loan is ultimately sold on the secondary market has not yet been determined, and thus has not yet been realized. On the other hand, in situations where a mortgage broker is part of the transaction, the YSP is realized and reported on the HUD-1 closing statement, but noted as paid outside of closing. If the YSP is used in part to pay for closing costs, the benefit accrues to the broker, who in turn has an obligation to report the amount as potential income. The question that needs to be answered is whether the borrower has constructive receipt of the YSP and must report this as income. Unlike the tax treatment of positive points, there are no authoritative pronouncements concerning the tax treatment of borrowers receiving negative points. The most likely reason for

9 8 the lack of authority concerning negative points is that few borrowers actually walk away from a home financing or refinancing transaction with cash in their pocket. This is apparently so uncommon that there is no place on the Form 1098 Mortgage Interest Statement to report negative points. Even the instructions for Line 5 the blank line used to report other information do not mention negative points. Currently, because there is no Form 1098 used to track the amount of a YSP and only transactions with a broker assure that there truly is a YSP realized, the amount of the YSP is not acknowledged by the IRS. We will examine three scenarios in which borrowers use negative points either explicitly or implicitly as part of their home financing transactions. First, we consider a loan with zero explicit loan origination fees. The second scenario is a no-closing-cost loan. Finally, we consider a scenario wherein the borrower directly receives cash from the lender. In the first two scenarios, the taxpayer agrees, either explicitly or implicitly, to pay an above par interest rate in exchange for paying no loan origination fee (Scenario I) or paying no closing costs at all (Scenario II). In the third scenario, the assumption is made that the lender explicitly discusses how much cash the borrower receives depending on the interest rate of the loan. B. Negative Points to Cover Loan Origination Fees Mortgage banks and mortgage brokers typically charge a loan origination fee for the services they provide in connection with a mortgage loan. Borrowers often have the option to exchange this fee for a higher interest rate. Even though lenders consider loan origination fees to be compensation for making a loan at par, it is generally considered prepaid interest for tax purposes (Reg H-1(f)(1)(i) and IRS Publication 936). Therefore, the tax consequences of the alternatives depend on the circumstances of the loan. If the loan is for the purchase or substantial improvement of a borrower s primary residence, the choices are: Option 1) making a

10 9 tax-deductible payment of prepaid interest at the time of the loan and making lower monthly payments with less deductible interest over the life of the loan; or Option 2) paying no origination fee and making higher monthly payments with more deductible interest over the life of the loan. If the loan is for qualified home mortgage indebtedness other than for the purchase or substantial improvement of a primary residence, then the loan origination fee in Option 1 would be amortized over the life of the loan (IRC 461(g)(1) and 263(a)). Any unamortized loan origination fee upon sale or refinancing with a different lender would be deductible in the year the loan is terminated (Reg T(j)(3) and IRS Publication 530). Even though the lender factors the receipt of a yield spread premium in the above scenarios, negative points are not a tax issue because the choices for tax purposes are whether to prepay interest on a lower-rate loan or prepay zero interest on a higher-rate loan. However, negative points may be a tax issue if, alternately, the lender fee being waived is not considered to be prepaid interest e.g., stated in the HUD1 as a lender fee then option 1 will have a higher after-tax cost because the lender fee is not deductible ((IRC 461(g)(2)). Instead, the lender fee only increases the borrower s basis in the home. Moreover, if the home in question qualifies as the taxpayer s primary residence for at least two of the last five years when the taxpayer sells the home, then the increase in basis will provide no tax benefit as the gain on the sale of the residence will likely be excluded under IRC 121 (gain exclusion of $250,000, or $500,000 if married filing jointly). C. Negative Points to Cover Closing Costs Another financing option available to borrowers that makes use of a YSP is a no-closingcost loan whereby the lender pays all of the closing costs. Borrowers pay a higher than par

11 10 interest rate in exchange for paying no cash other than for a down payment on an initial home purchase at closing. Though the amount of closing costs varies, closing costs are often significant. Typical closing costs can exceed 2 percent of the loan balance. No Actual or Constructive Receipt of Negative Points One issue related to a no-closing-cost loan is whether or not the borrower constructively or actually received the amount of the closing costs. In most cases, the borrower does not receive additional proceeds equivalent to the closing costs and the loan documentation does not show a yield spread premium being allocated to cover the borrower s closing costs. When this occurs, the tax treatment is straightforward. The borrower is not entitled to deduct any of the otherwise deductible items associated with closing costs such as the borrower s portion of real estate taxes. Also, the borrower does not increase his or her basis in the house for nondeductible items such as title insurance and title search fees. However, since the loan carries an above par interest rate which results in the lender receiving a YSP the borrower will have higher monthly payments that result in larger interest deductions as compared to receiving a loan at par. Actual or Constructive Receipt of Negative Points Actual receipt occurs when the lender includes the closing cost amount in the proceeds that the borrower receives from the lender. The borrower would only have constructive receipt of the funds if the loan documentation shows that a portion of the yield spread premium was earmarked for the borrower and used to cover the closing costs. Although actual or constructive receipt of a YSP to cover closing costs is unlikely, the tax treatment of the negative points constructively received would be the same as in the discussion below about the tax treatment of negative points actually received in excess closing costs.

12 11 D. When Negative Points Exceed Closing Costs In some instances, buyers may negotiate a higher interest rate on their mortgage to cover their closing costs and receive cash from the loan transaction. In this situation, it is clear that the borrower has actual receipt of negative points in the amount of the cash received. Amortization of Negative Points During the Life of the Loan A borrower receiving negative points is analogous to a corporation receiving a bond premium. Corporations issue bonds at a premium because the bonds pay a higher interest rate than the market demands for a bond with the same characteristics (risk, duration, features). The bond premium represents a reduction of interest expense that is amortized over the life of the loan (IRC 171 and IRS Reg ). Therefore, amortizing negative points over the life of the mortgage is consistent with corporate treatment of a bond premium. That is, the amortization reduces the interest deduction on the home loan. Furthermore, amortizing negative points over the life of the loan is consistent with the general rule for tax treatment of positive points. Given that home borrowers use the straight-line method for amortizing positive points, it is reasonable to take the position that home borrowers should amortize negative points using the straight-line method (IRC 461(g)(1) and 162(h)(3)(C)). Tax Treatment of Unamortized Negative Points upon Debt Cancellation If a corporate bond is retired prior to maturity, the corporation has a gain if the amount paid to satisfy the debt is less than the corporation s basis in the bond (Reg (c)(2)(ii)). A corporation s basis in its bond is the face value plus the unamortized bond premium. In the Internal Revenue Code, retiring any debt for less than its basis results in income from the discharge of indebtedness under IRC 61(a)(12) unless specifically excluded by 108. Although IRC 108(a)(1)(E) temporarily ( ) excludes income from discharge of indebtedness on

13 12 a principal residence, this exclusion does not apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer (IRC 108(h)(3)). Therefore, unamortized negative points are taxable income upon debt retirement. Moreover, the character of the income is ordinary (U.S. v. Davenport, Tommy D., (2005, DC OK) 97 AFTR 2d , USTC 50167, 412 F Supp 2d 1201). One likely exception to reporting unamortized negative points as cancellation of debt income occurs when borrowers refinance their debt with the same lender. In this case, the unamortized negative points are amortized over the life of the new loan. This conclusion is based on the same treatment being given to positive points (IRC 163(h)(3)(C)(ii)). The reasoning behind rolling the positive points over to a refinancing loan with the same lender appears to be the substance over form doctrine. That is, the second loan is simply treated as a continuation of the original loan rather than treating them as two separate loans. Although IRC 61 and 108 and related Regulations indicate that the unamortized negative points are taxable income in the year of debt cancellation, a question remains about the consistency of this treatment when comparing it to the tax treatment of unamortized positive points upon debt cancellation. Borrowers who have unamortized positive points when they extinguish their debt are allowed to deduct the remaining unamortized points as an interest deduction in the year of extinguishment. Therefore, it seems reasonable that home borrowers should first reduce their deductible home mortgage interest by the remainder of the unamortized negative points in the year the debt is extinguished. If one were to follow the bond-premium line of reasoning, any remaining unamortized negative points would be treated as income from the discharge of indebtedness under IRC 61(a)(12).

14 13 At first glance, it appears that reducing the amount of debt cancellation income while decreasing the amount of deductible home mortgage interest yields the same results as simply reporting all of the unamortized negative points as gross income. However, many deductions and credits are phased out based on AGI, including the overall limitation on itemized deductions, the child tax credit, and the deductibility of personal exemptions. Consequently, using unamortized negative points to reduce the amount of deductible home mortgage interest in the year of debt cancellation produces the best result. IV. AFTER-TAX DISCOUNTED CASH FLOW ANALYSIS ILLUSTRATING USE OF NEGATIVE POINTS To illustrate the effect of using negative points, we present four examples in Exhibit 2: (Loan Ia) a positive-point loan on a new home purchase, (Loan Ib) a positive-point refinance loan, (Loan II) a negative-point loan to cover closing costs, and (Loan III) a negative-point loan that covers closing costs and provides cash to the borrower. The loan amount is $200,000 and the interest rates are based on the 30-year fixed rates presented in Exhibit 1. The loan origination fee is 75 basis points, and other closing costs excluding prepayments are assumed to also be 75 basis points. The loan duration is five years. Finally, the discount rate employed in all four scenarios is two percent because that approximates the after-tax return on five-year treasury notes for our hypothetical taxpayer who is in the 28% tax bracket. Exhibit 2 clearly shows that the negative-point loans produce a higher after-tax net present value (NPV) than do the positive-point loans. This difference becomes greater as the actual duration of the loan decreases. The worst loan is Loan Ib, refinancing with positive points, because this loan requires an up-front cash payment with the related tax benefits recovered over the life of the loan.

15 14 The best loan is Loan II, the negative point loan that only covers closing costs. Even though Loan III results in a cash inflow at closing, Loan II results in a higher NPV because the increase in interest rate to compensate the lender for paying $1,500 (75 basis points) cash at closing is higher than the interest rate increase to cover the $3,000 (75 basis points for loan origination fee and another 75 basis points for other closing costs. Moreover, the comparison between Loans II and Loan III reveals that few borrowers will walk away from closing with cash from negative points because the cost of negative points quickly becomes prohibitive. Loan III assumes that the borrower is either very knowledgeable about taxes or has received professional advice and properly amortizes the negative points to reduce the amount of deductible interest during the life of the loan and reports the unamortized negative points upon cancellation of the loan as income. In contrast, a borrower who did not amortize the negative points would only be understating the present value of his or her tax liability by $383, or 2.4% of the present value of the tax savings from interest deductions likely too small an amount to become a priority for increased IRS enforcement. V. WHY IRS DOES NOT SPECIFICALLY ADDRESS TAX CONSEQUENCES OF NEGATIVE POINTS One of the reasons the IRS may not have worried much about taxing a source of income to the borrower is the fact that the amount of negative points is typically limited by the lender. Noting that most mortgages have a life of five to seven years, lenders who are in the business of recouping a present value outlay in the form of a YSP, must factor that paying a high number of negative points will only accelerate the desire on the part of borrowers to refinance the mortgage. Thus, a lender would only pay a high amount of points to a borrower if the lender included a clause barring the borrower from refinancing the loan for a number of years. In addition, if

16 15 lenders paid a high number of negative points, the lender would be increasing the likelihood of default by producing a money-making scheme that would allow a borrower to withdraw cash from the transaction. Moreover, this would only encourage a borrower to refinance or to default on the loan. For all practical purposes, negative points are a contra-account to the downpayment. Most lenders understand that a higher down-payment serves as a greater incentive for the borrower to keep making payments. Increasing the YSP and coupling this with a small downpayment would only make the borrower more likely to default. Furthermore, the majority of the negative points may not actually benefit the borrower. Because the payment of negative points occurs on the HUD-1 form in a line called Paid Outside of Closing or POC, many borrowers do not even know that the negative points have actually been accrued and paid to the broker. Combined with the fact that most borrowers are not extracting cash from the creation of negative points, but rather paying associated closing costs, it may be easy to see why the IRS does not pursue taxing this potential source of income. Finally, in the cases where a mortgage banker is used 5 at the time of closing, if a borrower agrees to take a higher than par rate, there are no negative points realized until the loan is sold on the secondary market, even though the banker and the borrower may have agreed to decrease or lower the closing costs. Thus, the IRS would have a difficult time establishing that the higher interest rate was in fact exchanged for the benefit of decreasing closing costs. Furthermore, even if a mortgage broker is used, there may be no explicit recognition of negative points. Some brokers may avoid explicitly creating negative points by simply booking the higher rate and internally deducting the closing costs without noting the negative points at closing. It may well be that the instances, where a mortgage broker is used and the amount of

17 16 negative points creates a cash flow to the borrower, are so infrequent that the IRS has not bothered to regulate the transaction. VI. CONCLUSIONS This article examined, from a tax perspective, the decision to both pay and to receive mortgage points. While the tax treatment afforded to positive points is well understood by most practitioners, the receipt of negative points is mostly devoid of tax authority. This article focused on situations where negative points were used to cover closing costs, and the more interesting case, where cash was being pulled out of the closing transaction. As mentioned previously, the lack of regulation may well be due to private incentives by lenders to rein in the payment of negative points. However, this may miss the larger picture of whether public policy is being well served by this lack of governmental oversight. In light of the current problems with the sub-prime mortgage market, it appears that negative points, while promoting many worthwhile objectives including the financing of closing costs, also result in a larger monthly mortgage payment. This fact cannot be overemphasized. With a higher mortgage payment, the probability of default also increases. It appears that Congress may well consider using the Tax Code as it has been known to do in the past to influence the behavior of weaker borrowers to avoid using negative points to lower their closing costs. 6 Specifically, Congress may want to limit the use of negative points to borrowers that have higher FICO 7 scores, as well as limit the use of cash producing negative points to only the most credit worthy borrowers. Secondly, IRS may want to promulgate specific Regulations that make the actual receipt of a de minimis amount of cash say less than $1,000 a non-reportable

18 17 transaction. This would provide comfort to both practitioners and taxpayers that their current non-reporting of the cash is not a cause for concern. Finally, while it may be preferable for the private sector to police themselves, the time may be right for the IRS to provide more guidance and a more defined regulatory framework with regard to negative points. Even though the government has tried on many occasions to regulate consumer disclosure requirements, 8 the Income Tax Regulations may be used as a different means of accomplishing the same result protection for the credit borrower from questionable lending practices, the unscrupulous use of negative points without the proper disclosure.

19 18 REFERENCES Clauretie, T., G. Sirmans, Real Estate Finance, Theory and Practice, (Mason, Ohio 2006) 5 th Edition, Thompson/Southwestern. de la Torre, C., C. McClatchey, Psst Hey, Buddy, want to buy a mortgage? Journal of Personal Finance, 5 (Forthcoming Summer 2006). Geltner, D. M., N. G. Miller, Commercial Real Estate Analysis and Investments, (Mason, Ohio 2001) Thompson/Southwestern. Jacobus, C., Real Estate Principles, (Mason, Ohio 2006) 10 th Edition, Thompson/Southwestern. Ling, David C., W. R. Archer, Real Estate Principles A Value Approach, (New York, 2005), McGraw-Hill/Irwin, McClatchey, C., C. de la Torre, Comparing Fixed Rate Mortgage Loans via the Annual Percentage Rate: Cautions and Caveats, Journal of Financial Services Professionals (January 2006). Miller, Norman G., David M. Geltner. Real Estate Principles for the New Economy, (Mason, Ohio 2005), Thompson/Southwestern. Mukherji, S. A Spreadsheet Model for Analyzing Home Buying and Financing Decisions, Advances in Financial Education, (Spring 2005), Wiedemer, J. P., J. Goeters, Real Estate Investment, (Mason, Ohio 2003) 6 th Thompson/Southwestern. Edition,

20 19 ENDNOTES 1 Lenders specialize in different types of loans to certain borrower types; a retail mortgage broker is able to shop multiple lenders for the best rate/fee combination specific to each client enabling them to perform the function more efficiently in many cases. 2 If interest rates decline during the period between the initial price quote to the borrower and the lock date and the borrower is not aware of it, the broker can keep the loan at the same quoted rate, and retain the YSP as extra income. See Dr. Jack Guttentag s website, Mtgprofessor.com for more information, and specifically the following entries of 10/3/01 and 4/22/02. 3 In these transactions, the loan originator and lender is outside of RESPA s coverage under the secondary market exceptions found at 24 CFR (b)(7), which states that payments to and from other loan sources following settlement are exempt from disclosure requirements and Section 8 restrictions. 4 Dr. Jack Guttentag s website, Mtgprofessor.com, also discusses the concept of an Upfront Mortgage Broker that is a voluntary program whereby an affiliated broker works with the credo of openly discussing the compensation model in full detail with the consumer, including the use of the YSP. 5 A mortgage banker uses their own funds to make the loan. 6 The misuse of negative points has been well documented, including the need to reform the disclosure of negative points. See de la Torre & McClatchey. 7 Named for Fair, Isaac & Co., the firm that developed the calculation, a FICO score measures an individual s use of credit. Borrowers with a FICO score of greater than 700 can borrow to a LTV ratio of 100%. 8 As recently as 2004, HUD Secretary Alphonso Jackson proposed a reform rule to the Real Estate Settlement Procedures Act (RESPA). Due to extensive and widespread criticism, the proposed changes were tabled. Undeterred, Secretary Jackson recently announced (July 1, 2005) a set of roundtable talks focusing once again on issues such as reforming the good faith estimate procedure as well as a more complete disclosure of broker compensation. See Simplifying and Improving the Process of Obtaining Mortgages to Reduce Settlement Costs to Consumers, 67 Fed. Reg (July 29, 2002) for an example of a proposed final rule that was not adopted.

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