Last week we talked about how to get commercial loans. If you have only done residential loans, you may not have dealt with points. Rarely do points make an appearance in residential loans. Today, we talk about the mysterious system of points.
Points are a way of talking about a percentage of the total amount loaned. One point equals 1% of that amount. If a person is looking for a mortgage to purchase a $500,000 house at 80%LTV (Loan-to-Value), 3% rate, and a 30-year term, they would be borrowing 80% of the total, or $400,000. If he is considering paying one point, then he pays 1% of the 400k, or $4,000. He could also consider a fraction of points, such as 1.25 points.
Points in residential loans
In this scenario, points means discount points. They are a way for the purchaser to ‘buy down’ the mortgage rate. By paying points, the lender may offer to decrease the interest rate for the life of the loan. Let’s say it is 0.5%, which is huge. The loan above would have paid $207,109.81 in interest over the life of the loan. By paying 1 point, the interest rate goes down to 2.5% and the total interest is $168,974.09. That’s a savings of about 40k at a cost of 4k! The person getting the loan needs to understand that money now is worth a lot more than it is 30 years down the road, when they realize the total savings.
More importantly, if they were to sell the property, they would need to pay back the loan early, and would not get as much benefit of the low interest rate. They would likely lose money due to the 4k points payment. That very issue happened to me on my first house. I paid 1.5 points and had calculated how much I would save, only to sell the house and move to a different state 3 years after the purchase. In retrospect, paying points was a bad decision.
Points are paid at closing and have the effect of increasing closing costs to the buyer. This must be considered when deciding on paying points.
Points in commercial loans
I’m going to clump any non-residential loan in here. This could be a mortgage or a private money loan. Here, points aren’t discount points. They are just a fee that the lender receives upon closing of the loan. They are still 1% of the total loan amount.
Pay attention to what points the lender is charging when looking for a commercial loan. This fee can make the difference between working with one lender or another one.