What Are Points on a Hard Money Loan?

Hard money loans represent a specific type of financing often utilized in real estate investments or by borrowers who may not meet the strict criteria of traditional bank loans. These loans are typically secured by real property, focusing primarily on the asset’s value rather than the borrower’s credit history. Hard money loans frequently involve unique fee structures, including “points,” which directly influence the total cost of borrowing for the individual.

Defining Loan Points

In the context of a hard money loan, “points” refer to an upfront fee charged by the lender. One point is equivalent to one percent of the total loan amount. These fees are expressed as a percentage, such as “2 points.” For instance, if a borrower secures a $200,000 hard money loan with a charge of 3 points, the upfront fee would be $6,000.

These points are a one-time charge, distinct from the ongoing interest rate applied to the loan. Borrowers typically pay these points at the loan’s closing, making them part of the initial cash outlay required.

Purpose and Calculation of Points

Hard money lenders charge points for several reasons, to compensate for the elevated risk of these loans. Hard money loans often cater to borrowers who require rapid funding or do not qualify for traditional bank loans due to their financial profile or the nature of the investment. The less stringent qualification requirements and faster processing times inherent in hard money lending contribute to this increased risk for the lender. Points typically cover various costs for the lender, such as loan origination, underwriting expenses, and administrative overhead. They also serve as a form of early compensation for the lender, given the often short-term nature of hard money loans.

To calculate the cost of points, multiply the loan amount by the total percentage of points charged. For example, if a borrower takes out a $300,000 hard money loan with a charge of 4 points, the calculation involves multiplying $300,000 by 0.04 (4%). This results in a $12,000 fee for the points. The number of points charged can vary, typically ranging from 2 to 10 percent of the loan amount, depending on factors like the risk of the loan, the property type, and the borrower’s experience.

Impact on the Overall Loan Cost

Points significantly influence the overall cost of a hard money loan by increasing the initial financial commitment. As an upfront fee, points add directly to the cash required at closing. For instance, a loan with 5 points on a $500,000 principal means an additional $25,000 due at the outset. This immediate expense can impact a borrower’s liquidity for other project-related costs.

The true cost of a loan is better understood through its Annual Percentage Rate (APR), which incorporates both the stated interest rate and certain upfront fees. While a loan might advertise a specific interest rate, the inclusion of points effectively raises the total cost of borrowing beyond that nominal rate. The APR provides a standardized measure that allows borrowers to compare the actual yearly cost across different loan products.

For example, consider a $100,000 hard money loan with a 10% annual interest rate and 3 points. The interest alone would be $10,000, but the 3 points add an additional $3,000 in upfront fees. This means the borrower effectively pays $13,000 for the use of the $100,000, making the true cost of the loan higher than the stated interest rate suggests. The APR reflects this combined cost, providing a more accurate picture of the loan’s expense. Borrowers should evaluate the APR when considering hard money loans, as it provides a clearer understanding of the total financial obligation.