Points is a term used in almost all hard money loan transactions. Points indicate the cost of a loan, and are a percentage of the loan amount. So a hard money loan with a cost of 5 points would be the same as saying the cost of the loan is 5% of the loan. It is similar to how real estate agents get paid, a percentage of the property sales price, but instead of ‘percentage’, hard money lenders refer to these fees as points.
Many borrowers are confused as to why they must pay points on hard money loans. Hard money lending is different than getting a loan from the bank. If you go directly to the bank, they make you the loan and the person who helps you is an employee of the bank. The bank pays them a salary. After the bank makes the loan they typically sell the loan (while some hold it for the interest return). When the loan is sold, the bank makes money on that sale depending on the rate and terms. For example, if a bank makes a loan of $100,000, they may sell it for $103,000. In this manner, everyone is being paid through the bank.
On hard money loans there is no bank involved. There is no person who is making a salary (generally speaking) helping you. Instead the broker or individual representing you is paid only on commission. In addition, the loan is not being sold but rather is being funded directly by an investor or group who intends to hold the loan to make a return on their money (the interest rate). So since the loan is not being sold, and the person helping is not being paid a commission, the borrower must be charged to pay these people so they can continue to stay in business.
In addition to paying the people involved in helping you, often times the end investor is also getting paid an upfront return in addition to the interest rate. This helps to guarantee a minimum return to the investor. Basically with hard money all of the fees pass through to the borrower, there are no yield spread premiums like there are for brokers who work with the banks (where the banks pay the brokers). While it may seem expensive, when you think about it the cost is less than a typical real estate commission people pay. Most real estate commissions seem to be about 6%. While some hard money loans cost 6 points or more (usually the more aggressive loans), many are actually less expensive with a cost of 4-5 points.
Hopefully this helps to explain not only what the term ‘points’ means, but also why they are charged on hard money loans.