What are Points on a Hard Money Loan & How Do They Work?
If you’ve ever been interested in acquiring a hard money loan for an investment property, you’ve likely come across the term “points”. So, what exactly are points when it comes to hard money loans?
Before we discuss points, let’s take a look at what a hard money loan is.
What Is a Hard Money Loan?
A hard money loan is a non-traditional loan given from a private lender in which the asset being purchased with the loan doubles as collateral for the loan. These loans are also referred to as short-term bridge loans, as they “bridge” the gap between long-term financing and investment purchases.
Hard money loans are primarily used for real estate transactions and help speed up home financing, because they can help expedite the process between buying and selling a property. However, they do have a few other potential uses, and could be very helpful for providing funding, depending on your goals.
Funds from hard money loans come directly from private investors rather than traditional lenders, and the property itself being purchased acts as collateral. If for some reason you can’t repay the loan, hard money lenders will then sell that property in order to get their money back.
These loans typically have shorter terms than most mortgages and usually last one to three years. They act as an alternative to traditional loans from the bank, especially in situations that can be risky, such as house flipping. If you’re interested in fix-and-flips, feel free to check out our in-depth guide here. Hard money loans are useful for these types of projects as well as a multitude of other situations.
What Are Points On a Hard Money Loan?
So, now that we’ve discussed hard money loans, what exactly are the “points” that are associated with them?
Points act as a way of paying interest upfront in order to get a reduced interest rate on a fixed-rate home mortgage. Ultimately, the more points that you pay, the lower your interest rate will be over the entire course of the loan.
Points are based upon one percent of the total amount of the loan. For example, if a lender quotes you five points, it means 5% of your loan amount. So, if your loan is $50,000 with five points, that means the fee would be $2,500.
Different Types of Points On a Hard Money Loan
There are two different types of points involved when considering using a hard money loan for purchasing a property.
Discount points are like prepaid interest on your loan that you are getting for your new home. The number of points that you choose to buy will depend on how much you want to reduce your interest rate. Under certain conditions, buying mortgage points are tax-deductible.
For every discount point you buy, your interest rate will be reduced by a certain percentage. The per-point discount you’ll receive in return varies from lender to lender, but you can generally expect to get a 0.125% to 0.25% interest rate reduction for every point that you buy. Almost all lenders put a limit on the number of points you can buy, and most of them allow you to purchase a fraction of a point.
Origination points can be charged by the lender to pay for the costs of making the loan. They are tax deductible only if the points were utilized to get the home mortgage and not to pay other closing expenses.
The Benefits of Hard Money Loan Points
Depending on your situation, buying points on a hard money loan can be beneficial in saving you money in the long run. Points are bought to lower the interest rate over the period of the hard money loan and save on the cost of the loan.
While points can elevate your closing costs by thousands of dollars, the upfront cost might be worth it if you plan on staying in the home long enough to see savings from the reduced interest rate. Paying an additional $3,000 upfront could mean that you save tens of thousands of dollars over the course of your mortgage. However, if you don’t plan on staying in a home long-term, and if you plan to sell your home before your break even, paying for points might not be the best option for you.
Points also serve as a way of getting lower monthly payment. If your monthly payment is too taxing on your budget, points could be a great way for you to save money. At the end of the day, a lower interest rate means lower monthly payments.
There’s also a possibility that you save money on taxes if you decide to purchase hard money loan points. Since hard money loan interest is tax deductible and points are considered prepaid interest, you may be able to deduct the cost of the points on your taxes.
When Should I Buy Points On a Hard Money Loan?
If you plan on staying in your home for a long period of time, buying points on your loan may be a good idea.
The longer you plan on living in your home, the more sense it makes to utilize hard money loan points and a lower interest rate. If you’re positive that you’ll have the same payment for a long time, points can lessen the overall cost of the hard money loan. The longer you stick with the same loan, the more money you’ll save with points in the long run.
You can also consider buying points on a hard money loan if you have determined when your breakeven point is, and it works in your favor.
Eventually, you will break even on your hard money loan points and will see savings from your decision. You can calculate this by taking the total cost of the points, then dividing that number by the amount of money you are saving monthly. The result of this equation will be the number of months it takes for you to break even.
If you plan on staying in your house long-term and you know you won’t move or refinance before you hit the breakeven point, you should consider buying points.
When Should I NOT Buy Points On a Hard Money Loan?
There are also a number of reasons why buying points on a hard money loan may not be the right decision for you.
If you don’t plan on staying in your home for long, buying points may not be the best idea. If you have a job that requires you to relocate every few years, you won’t see much benefit from buying points. It takes time for the money you save on interest to break even on the amount you spend to buy hard money loan points. If you know you plan on moving at any point in the near future, points probably aren’t worth buying.
If you plan on paying extra on your hard money loan payments, buying points may not be best for you. Hard money loan points will only benefit you if you plan on paying for your loan over a long amount of time. If you have the ability to pay off your loan quickly, you most likely won’t save much money.
Another reason you should avoid buying points on a hard money loan is if you don’t have the money to buy points. At the end of the day, it isn’t worth emptying your savings to save on interest down the road. Instead, you could save on interest in the long run by putting extra money toward your down payment when you have the ability to do so.
In conclusion, buying points on a hard money loan could be beneficial for you depending on your situation.
If you’re in a situation where you plan on staying in one place for an extended period of time, buying points on your loan may be worth it. As long as you take the time to calculate your break even point, you could end up potentially saving thousands in the long run.
However, if you’re someone who needs to relocate often due to job or family circumstances, then buying points on your hard money loan likely isn’t worth it.
Ultimately, when it comes to buying points on a hard money loan, be sure to do the proper research and make the decision that will benefit you most long-term.
We would be remiss not to advertise our own services at Hard Money Lenders IO in getting you the hard money loan you need to buy an investment property. We fund loans for fix and flips and distressed properties, but we also offer a variety of resources for your real estate investing journey.
We offer a loan calculator to get a projection of the rates and terms of your hard money loan. We also offer a private money lenders directory so you can compare hard money lenders near you and find the best possible hard money lender for you, even if you determine we’re not the best partner for your real estate investing journey.
We also offer loans to foreign nationals and new investors, two groups of investors who typically have a hard time qualifying for hard money loans. While we are a Miami, Florida-based company, we believe every investor should have access to the best possible loans at their disposal.
Look no further for a partner in researching, financing, and buying your cash only property.
Adam Smith has spent the last 5 years in the Private Money Lending world helping real estate investors secure financing for their non-owner occupied real estate investments. When he’s not thinking about real estate, Adam is an avid Jazz music fan and fisherman.