Discount points have been in the news recently. A recent article from the Federal Reserve citied possible UDAAP and Fair Lending violations resulting from unearned discount points. Revisions to Regulation Z, emanating from the Dodd-Frank Act, change the whole game with points. So why the current emphasis on the age-old practice of charging points?
Discount Points Primer – Many lenders offer borrowers the option of obtaining a lower interest rate on a mortgage loan by paying discount points. The upfront payment for points lowers the amount of interest paid over the life of the loan. Generally, each discount point costs 1 percent of the total loan amount and usually lowers the interest rate by 25 basis points. For example, on a $100,000 mortgage loan the purchase of one discount point would cost $1,000. Paying the point would generally lower the interest rate by 25 basis points, from 5% to 4.75% percent.
Not all points are discount points. Some lenders charge an origination fee in the form of points. Rather than imposing a flat fee to cover the bank’s costs in making a loan the lender imposes a fee calculated as a percentage of the loan amount.
Both borrowers and lenders benefit from discount points. Borrowers benefit from lower interest payments over the life of the loan, but it may take several years for the lower payments to offset the upfront payment for the point. And discount points are generally tax deductible. Lenders benefit by receiving an upfront cash payment.
Series of Articles – Lenders must ensure that discount points are “earned.” When a consumer pays a fee to buy down the rate, they should receive a reduced rate. Discount points are “unearned” when the consumer pays the fee and does not receive a reduced rate..
We plan to explore these issues related to unearned discount points in a series of blog articles. The articles:
- Consider possible UDAAP concerns that result from unearned discount points;
- Explain how unearned discount points may result in a Fair Lending violation;
- Review recent proposed amendments to Regulation Z that fundamentally change the way discount points are managed; and
- Provide steps to assure potential problems are avoided.