Negative points is a term that is used to describe a cash rebate that a lender credits to a borrower as a means of offsetting the costs of settling a loan. In most cases, this type of rebate is provided in situations that involve the arrangement of a mortgage. Depending on the manner in which the mortgage deal is arranged, the mortgage broker may receive the rebate rather than the borrower, with the negative points usually identified as a yield spread premium in that scenario.
Lenders calculate negative points based on what is currently identified as the par interest rate. This simply means the standard rate that the lender uses when extending loans of different types, including mortgages. When the interest rate extended is above that par rate, negative points are issued. For example, if the mortgage is set to use the par interest rate of 5%, the negative points are nil or zero. Should the borrower go with a 5.5% interest rate, the negative points might be –2 points.
The use of negative points make it possible for a borrower with limited funds to still arrange to pay the settlement costs associated with the mortgage. In granting this type of rebate, the amount cannot exceed the actual amount of the settlement costs, and the borrower cannot divert the points so that they are applied to the down payment. This rebate covers those settlement costs, allowing the borrower to enjoy what amounts to a no-cost mortgage.
When a mortgage broker is attempting to secure a mortgage on behalf of a client, there is a good chance that the savings earned with the negative points will actually go to the broker and not the client. In situations of this nature, the amount is often included in the commission or general compensation that the broker receives. Depending on the terms of the mortgage and the creditworthiness of the borrower, this arrangement could still result in obtaining the best rate possible under the current circumstances.
While the idea of negative points is an excellent strategy in many cases, there are situations in which the borrower may want to avoid those upfront costs altogether, and go with a slightly higher interest rate. This is particularly true if the plan is to only hold the mortgage for a short period of time, such as in a situation where the borrower plans on making improvements to the property and then sell it at a profit within the next four to six months. In situations where the idea is to hold the mortgage for the long term, then incurring the upfront costs and obtaining a lower mortgage rate is the best option.
