Points and interest rates operate separately but should be considered together when assessing the total cost of any loan.
In the California private lending market, points are an important cost that can significantly affect the economics of a deal.
Experienced flippers budget for points in the same way they budget for:
- rehab costs
- insurance
- holding costs
- closing fees
Here’s how they work.
What are points?
Points are upfront fees lenders charge as a percentage of the loan amount.
One point is equal to 1% of the loan.
Consider a $500,000 loan that attracts two points.
A simple equation of 2% x $500,000 confirms an additional fee of $10,000.
They are typically paid at closing and are separate from:
- interest payments
- appraisal fees
- title fees
- escrow costs
- construction or rehab costs
Why lenders charge points
Private and hard money lenders in California fund a variety of projects including:
- transitional properties
- distressed homes
- construction projects
- time-sensitive acquisitions
Many of these projects involve a higher level of risk and the charging of points helps fund this risk and flexibility.
Points help compensate lenders for:
- originating the loan
- underwriting risk
- deploying capital
- short-duration financing
Sometimes, lenders may offer lower interest rates in exchange for higher points.
For instance, a standard interest rate of 11.5% may attract no additional points.
But a lower rate of 10.5% might attract two points.
The borrower may have the choice of the option they prefer.
The points California borrowers typically pay
In California private lending, borrowers typically pay between 1-3 points on bridge and rehab loans.
They may pay more for higher-risk or highly leveraged projects.
Points structures vary significantly depending on the loan profile and market environment.
They are influenced by many factors including:
- deal complexity
- borrower experience
- leverage
- asset type
- market conditions
How experienced investors evaluate a deal
Experienced investors evaluate the entire capital structure of a deal and do not focus solely on points or interest rates.
They examine deals holistically considering a range of factors such as:
- speed of funding
- certainty of execution
- leverage offered
- draw structures
- loan term flexibility
- prepayment structure
- extension options
- overall profitability
Execution speed is pivotal in the fiercely competitive California real estate environment and can have a significant impact on profitability.
A lower-interest loan or one with fewer points may look attractive but may not be the cheapest if it:
- closes too slowly
- creates delays
- requires excessive contingencies
- causes an investor to lose the deal entirely
How points affect the economics of a flip
Points should always be included upfront when analyzing any deal.
Rookie investors can fall for the trap of underestimating transaction costs when underwriting deals.
For instance, let’s say a $600,000 loan attracts two points.
That additional $12,000 needs to be factored in along with interest payments, holding costs and rehab costs when determining:
- ARV
- projected margins
- contingency plans
Failure to do so is setting the project up for failure.
Disciplined underwriting is essential to ensure project margins are protected.
Rolling points into the loan
This is the practice of adding some or all of the points cost into the principal balance of the loan.
It may be offered depending on the lender, the borrower’s profile, their leverage and the deal structure.
Points may be fully financed, partially financed or paid out-of-pocket at closing.
But when rolled into the loan, it affects the borrower’s total leverage, their cash to close and the overall economics of the deal.
Generally speaking, the tactic is reasonable for short-term investment loans when the preservation of cash is important.
It is reasonably common in California among fix-and-flip loans, bridge loans and construction loans.
But it can be a dangerous option if leverage rises too high or the projection faces an uncertain exit.
That’s because the borrower ultimately pays interest on the points as well as the loan.
The longer the loan, the higher that cost will be.
The key question to ask when considering rolling points into a loan is: “Will preserving cash generate more return than the financing cost?”
Get finance and support today
Sophisticated flippers and developers look beyond ‘cheap money’, the lowest interest rates and points when analyzing lenders and their deals.
They prioritize reliability, speed, flexibility and above all, a trusted relationship with their lender.
That trust can only be created by successful repeat business between borrower and lender.
Experienced flippers know that certainty of execution, fast approvals, construction draw management and creative structuring is invaluable.
That’s because reliable financing can create opportunities that cheaper, slower capital cannot.
In California, Equidy is a hard money lender that offers borrowers all of this and more.
They can finance flippers and developers in as little as 48 hours.
They stand by their core belief that anything is possible and they strive to prove it every single day.
Even in tough economies, they are focused on rewarding entrepreneurship and resolve to help their clients crystallize their wealth creation dreams.
The real beauty of Equidy is that they work closely with their clients, sharing all the knowledge they have garnered in all aspects of property development for more than 40 years in California.
Their sole focus is to help you maximize the return on your investment without putting yourself at unnecessary financial risk.
Equidy enjoys long and established relationships with serious investors, sellers and real estate professionals while leveraging their reputation and trust, using clear communication to minimize the risk to all parties.
Contact Equidy today to book your free strategy call.
