Hard money lenders can be a lot more flexible than their conventional counterparts. They have room to customize everything from interest rates to terms to LTVs. Even points are on the table. Lenders and borrowers are free to work out whatever deal suits them both.
This is one of the most important concepts for real estate investors to understand, especially where interest rates and points are concerned. Why real estate investors? Because most hard money loans go to them.
Points on Hard Money Loans
Points are the harder of the two concepts to grasp, so let us start there. Actium Lending, out of Salt Lake City, Utah, explains points as origination fees. They represent a one-time, upfront charge paid at closing to cover the costs of funding the loan.
The general rule is that one point is equal to 1% of the total loan amount. On a $300K loan, a single point would be $3,000. Two points would be equal to $6,000. The money realized from origination points covers:
- Administrative costs
- Underwriting costs
- Risk assessment
Because hard money loans are short term by nature, origination points also contribute to the lender’s profit. This is important given that hard money loan terms are shorter. Also note that points are paid at closing, usually by deducting them from the actual loan proceeds.
Interest on Hard Money Loans
Interest on a hard money loan is identical to interest on any other kind of loan. It is charged as a percentage of the outstanding loan balance at the start of each month. Because most hard money loans are structured as interest-only loans, principle is not reduced during the term. That means the interest remains the same throughout.
The interest rate is a representation of the charge, based on a percentage. So on that same $300K loan mentioned earlier, a rate of 10% would work out as $30K. If we assume that the loan has a term of twelve months, we divide 30K by 12 to arrive at a monthly interest payment of $2,500.
With an understanding of both points and interest, it should be easier to understand which is more important to negotiate before signing a loan deal.
Negotiate the Points
On a hard money loan – and this does not apply to conventional loans – it is better to negotiate points. Points are fixed costs. They are time-agnostic. So by reducing points, the borrower saves money up front. That means more money to put toward the acquisition, which can ultimately lower monthly payments, even if by a little bit.
The key to remember here is that hard money loans are short term by nature. Terms of 6-12 months are normal. Very few lenders will go longer than 24 months. Why does this matter?
Time is the enemy where interest is concerned. The longer it takes to pay off a loan, the more interest the borrower ultimately pays. So if you are looking at a 15–30-year loan, total interest will far outpace origination points. You’re better off negotiating a lower interest rate instead.
On a short-term hard money loan, however, time isn’t much of a factor. Points can cost you more than total interest because you’re only paying on the loan for 6-12 months. You are better off negotiating lower points.
It Pays to Know These Things
Anyone looking to utilize hard money to finance an investment strategy should understand the difference between points and interest rates. It pays to know these sorts of things. In the end, it is better to negotiate lower points despite hard money interest rates being higher.
