In March 2008, we wrote an article here about the impact of mortgage insurance premiums on some state high cost loan tests.  In this article, we explore how discount points are treated under the various state high cost tests. 

Discount points are a form of prepaid interest - in return for paying a lower rate of interest over the term of the loan, a borrower agrees to pay discount points at loan closing.  A discount point is equivalent to 1% of the original principal loan balance.  Discount points are disclosed on page two, line 802 of the HUD-1 Settlement Statement. 

Discount points are a finance charge and, as such, the full amount of discount points paid by a borrower are included as a "point and fee" for purposes of the federal Section 32 high cost test, the Fannie Mae/Freddie Mac total points and fees test, and all state-specific high cost test calculations, in each case except as specifically discussed below.  

To the extent all or a portion of discount points paid by a borrower can be excluded from a high cost test, the applicable state high cost laws uniformly provide that the discount points must be in some sense "bona fide."  What constitutes a "bona fide" discount point, however, varies from test to test.  The following is a list of state-specific high cost tests that exclude all or a portion of discount points paid by the borrower, together with a brief description (to the extent available) of how "bona fide" is defined for purposes of each high cost test.

• Fannie Mae/Freddie Mac Points and Fees Test - all bona fide discount points paid by the borrower to the lender are excludable. No specific description of what constitutes a "bona fide" discount point is provided. For purposes of the Fannie Mae/Freddie Mac points and fees test, our DocMagic software assumes that all discount points paid by the borrower to lender only are bona fide.
  
  
• Arkansas - the following discount points to be excluded from points and fees:

(i)  up to two (2) bona fide loan discount points payable by the borrower, but only if the undiscounted interest rate does not exceed by more than one percentage point (1%) the required net yield for a ninety-day standard mandatory delivery commitment for a reasonably comparable loan from either Fannie Mae or the Federal Home Loan Mortgage Corporation, whichever is greater; or
(ii)  up to one (1) bona fide loan discount point payable by the borrower, but only if the undiscounted interest rate does not exceed by more than two (2) percentage points the required net yield for a ninety-day standard mandatory delivery commitment for a reasonably comparable loan from either Fannie Mae or the Federal Home Loan Mortgage Corporation, whichever is greater.

"Bona fide loan discount points" means loan discount points knowingly paid by the borrower for the purpose of reducing, and which in fact result in a bona fide reduction of the interest rate or time price differential applicable to the loan, provided the amount of the interest rate reduction purchased by the discount points is reasonably consistent with established industry norms and practices for secondary mortgage market transactions.

• Georgia - up to two (2) bona fide discount points may be excluded, but only if the undiscounted interest rate does not exceed by more than one percentage point (1%) the required net yield for a ninety-day standard mandatory delivery commitment for a reasonably comparable loan from either the Fannie Mae or Freddie Mac, whichever is greater.
  
  
• Indiana - an unlimited number of bona fide discount points may be excluded from points and fees. "Bona fide discount points" are defined as loan discount points that: (1) are knowingly paid by the borrower; (2) are paid for the express purpose of reducing the interest rate applicable to the loan; (3) reduce the interest rate from an interest rate that does not exceed the benchmark rate; and (4) are recouped within the first four (4) years of the scheduled loan payments. The "benchmark rate" is defined as the interest rate established under the high-cost provisions of TILA and Regulation Z, Section 32, that is, the corresponding yield on Treasury securities valued as of the 15th of the month preceding the month in which the application is received by the creditor, plus either 8% (for first liens) or 10% (for junior liens).

• Maine - up to two (2) bona fide discount points are potentially excludable from points and fees. "Bona fide discount points" means an amount knowingly paid by a borrower for the express purpose of reducing, and which in fact does result in a bona fide reduction of, the interest rate, as long as the undiscounted interest rate does not exceed the conventional mortgage rate as published in statistical release H.15 as of the 15^th day of the month immediately preceding the month in which the application is received by the creditor by more than two percentage points (2%) for a first lien loan or by three and one-half percentage points (3.5%) for a junior lien loan.

• Massachusetts - up to two (2) bona fide discount points are potentially excludable from points and fees. "Bona fide discount points" are defined as discount points that are knowingly paid by the borrower for the express purpose of lowering the interest rate, and which in fact do reduce the interest rate from an interest rate that does not exceed the benchmark rate. The "benchmark rate" is defined as the interest rate that the borrower can reduce by paying discount points so long as it does not exceed the weekly average yield on U.S. Treasury securities of five (5) years on the 15th day of the month immediately preceding the month in which the loan is made, plus four percent (4%).

• New Jersey - up to two (2) bona fide discount points are potentially excludable from points and fees. "Bona fide discount points" means loan discount points which are: (1) knowingly paid by the borrower; (2) paid for the express purpose of reducing, and which result in a reduction of, the interest rate or time-price differential applicable to the loan; (3) in fact reducing the interest rate or time-price differential applicable to the loan from an interest rate which does not exceed the "conventional mortgage rate" (defined as the most recently published yield on conventional mortgages as published in the Federal Reserve's H-15 Statistical Release as of the 15th day of the month immediately preceding the month in which the application is received by the creditor) by either two percentage points (2%)for a first lien loan or three and one-half percentage points (3.5%) for a junior lien loan; and (4) recouped within the first five years of the scheduled loan payments. Loan discount points will be considered to be recouped within the first five years of the scheduled loan payments if the reduction in the interest rate that is achieved by the payment of the loan discount points reduces the interest charged on the scheduled payments such that the borrower's dollar amount of savings in interest over the first five years is equal to or exceeds the dollar amount of loan discount points paid by the borrower.

• New Mexico - up to two (2) bona fide discount points are potentially excludable from points and fees. "Bona fide discount points" means loan discount points that are knowingly paid by the borrower for the express purpose of reducing, and which in fact do result in a bona fide reduction of, the APR otherwise applicable to the loan; provided, however that discount points are not "bona fide" if the APR otherwise applicable to the loan exceeds the "conventional mortgage rate" (defined as the most recently published yield on conventional mortgages as published by the Board of Governors of the Federal Reserve as of the 15th day of the month immediately preceding the month in which the application is received by the creditor) by more than either one and one-half percentage points (1.5%) for a first lien loan, or three percentage points (3%) for a junior lien loan.

• New York - up to two (2) bona fide discount points may be excluded. "Bona fide loan discount points" is defined as loan discount points knowingly paid by the borrower from any source for the purpose of reducing, and which in fact result in a bona fide reduction of, the interest rate applicable to the loan, provided the reduction purchased by the discount points is reasonably consistent with established industry norms and practices. A loan discount point is presumed to be bona fide if it reduces the interest rate by a minimum of 25 basis points provided all other terms of the loan remain the same. Loan discount points are excludable but only if the undiscounted interest rate does not exceed by more than one percentage point (1%) the yield on Treasury securities having comparable periods of maturity as of the 15th day of the month immediately preceding the month in which the application is received by the creditor; provided, however, all discount points may be deducted if they are paid through a federal, state or local government grant or a non-profit organization.

• North Carolina - up to two (2) bona fide discount points may be excluded. "Bona fide discount points" is defined generally as points knowingly paid for the purpose of reducing, and which in fact result in a reduction of, the applicable interest rate provided the amount of the interest rate reduction purchased by the discount points is "reasonably consistent" with industry norms and practices. Up to and including two (2) bona fide discount points are excludable provided the undiscounted interest rate does not exceed by more than one percent (1%) the required net yield for a 90-day standard mandatory delivery commitment for a reasonably comparable loan from either Fannie Mae or Freddie Mac, whichever is greater. Up to and including one (1) bona fide discount point is excludable provided the undiscounted interest rate does not exceed by more than two percent (2%) the required net yield for a 90-day standard mandatory delivery commitment for a reasonably comparable loan from either Fannie Mae or Freddie Mac, whichever is greater.

• South Carolina - up to two (2) "conventionally conforming" discount points may be excluded. "Conventional conforming discount points" is defined as loan discount points knowingly paid by the borrower for the purpose of reducing, and which in fact result in a bona fide reduction of, the interest rate applicable to the loan, provided the loan has an APR that does not exceed the "conventional mortgage rate" (defined as the required net yield for a ninety-day standard mandatory delivery commitment for a reasonably comparable loan from either Fannie Mae or Freddie Mac, whichever is greater) by more than one percentage point (1%). Up to two (2) conventional conforming discount points may be excluded if the undiscounted interest rate does not exceed the conventional mortgage rate by more than one percentage point (1%); up to one (1) conventional conforming discount point may be excluded if the undiscounted interest rate does not exceed the conventional mortgage rate by more than two percentage points (2%).

• Tennessee - up to two (2) bona fide discount points may be excluded. "Bona fide loan discount points" is defined as loan discount points actually paid by the borrower to the lender for the purpose of reducing, and which in fact result in a bona fide reduction of the interest rate applicable to the loan by a minimum of 25 basis points per discount point.

For a detailed description of each of our high cost tests, please review our high cost memos available online here.

Please contact DocMagic, Inc.'s Compliance Department if you have any questions or comments regarding this article.