What Are Negative Points?
Negative points are essentially rebates that lenders pay to real estate brokers or borrowers to help them afford closing on mortgages that they issue. This system allows some qualified borrowers, who could not otherwise afford the expense of closing costs and settlement fees, to be able to purchase a home. The downside, however, is that many mortgages with negative points will usually carry a higher rate of interest over the life of the loan. Negative points are usually expressed as a percentage of the principal loan amount, or else in terms of basis points (bps).
Negative points can be contrasted with discount points (also called closing points), which are purchased upfront as pre-paid interest by borrowers to lower their monthly cost over the term of the mortgage.
- Negative points are closing cost rebates offered by some lenders to qualified borrowers or mortgage brokers to reduce the up-front burden of closing.
- These rebates are intended to help certain homebuyers come up with enough cash for closing, which can be prohibitively expensive in some cases.
- Borrowers who receive assistance via negative points, however, will have to pay a higher interest rate over the life of the loan in return.
Understanding Negative Points
Negative points come in one of two general forms: to brokers and to borrowers directly. Rebates paid to a mortgage broker are known as a yield spread premiums (YSP) and are part of the mortgage broker's compensation. When the rebate is a borrower credit, it can be used to defray some loan settlement or closing costs. This borrower-use of negative points is known as a no-cost mortgage. The amount credited to the borrower may not exceed the settlement costs and cannot be a part of the downpayment. Negative points can be used to cover some nonrecurring closing costs, such as bank and title fees, but cannot be used to cover recurring expenses such as interest or property tax.
Negative points provide a way for borrowers with little or no money to pay the settlement costs to obtain a mortgage. However, the economics of using negative points depend on the borrower's time horizon. If the borrower intends to hold the mortgage for a short period, it can be economical to avoid upfront costs in exchange for a relatively higher interest rate. If the borrower intends to hold the mortgage for an extended period, it is most likely more economical to pay upfront settlement costs in exchange for a lower interest rate.
Example of Negative Points
Applying negative points to a mortgage increases the interest rate but can reduce closing costs. If a borrower accepts one negative point, the lender could raise the loan's fixed interest rate by 0.25% but give the borrower 1% of the loan as a credit against closing costs.
For example, a borrower seeks a $1,000,000 mortgage loan to buy a home. A quote for a loan with a 5% interest rate and two negative points would yield a $20,000 rebate to apply to the loan's closing costs ($1,000,000 x 2% = $20,000).
The more traditional loan structure for the same home purchase amount might be a loan at 4% interest and one point down payment. With this loan, there is a lower interest rate, but it requires the borrower to pay a $10,000 down payment.
Some mortgage brokers may not tell consumers about the availability of negative point loans. These brokers may be more concerned about their commission on the deal. Since, on the 5% loan, the broker would mark up the mortgage and keep the amount of the negative points as compensation for brokering the loan. Researchers have found that the mark-ups earned by mortgage brokers were persistently higher on negative point loans than on positive point loans. According to the study, on loans quoted by the lender at 6% plus 3 points, the mark-up to the borrower was 1 percentage point. But, on loans that were quoted at 7% and minus 2.25 points, the broker's mark-up was 2.375 points.
As a result, eligible homebuyers should be aware of negative point programs and actively ask their broker what their fee structure is. Remember that negative points will also raise the total cost of the mortgage interest paid over the life of the loan, increasing the monthly payments in order to compensate for the closing cost rebate.