Ask Cornerstone: What is the difference between interest rates and points?
A point is a fee paid upfront at closing for a loan. It is equal to 1% of the loan amount. One point on a $100,000 loan equals $1,000 (ergo, 3 points equals $3,000). The interest is the ongoing cost (computed as a percentage) which is charged for the use of money. It is expressed annually and calculated into your periodic (usually monthly) payments. Depending on the loan, you could be paying interest only, or interest plus payment towards the principle.
It is good to remember that high interest rates hurt you more in the long term loans, while high points hurt you more in short term loans. For an example, if you are flipping a property and you are going to need money only for 6 months; you rather pay higher interest than high points.
Example: $100,000 loan for 6 months at following rates:
- 12% plus 3 points. Total cost-$6,000+$3,000=$9,000
- 15% plus 1 point. Total Cost-$7,500+$1,000=$8,500
In the longer term loans opposite is true.
Example: $100,000 loan for 5 years at following rates:
- 10% plus 1 points. Total cost-$50,000+$1,000=$51,000
- 8% plus 5 points. Total cost-$40,000+$5,000=$45,000
(These interest rate and the amount of points are used only for demonstrating purposes.)
If you are trying to evaluate an investment to figure out what the best loan would be for your situation, try our flip calculator. It is an Excel spreadsheet that compares variables such as loan points, interest rate, purchase price, and After Repair Value side by side with your projected profit calculations for each scenario.
Good luck on your projects and thank you, Jorge R, for your question. This is good information for any new real estate investor!