Negative Points

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 — usually in exchange for paying 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 in terms of basis points (BPS). They 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.

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 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 down payment. Negative points can be used to cover some nonrecurring closing costs, such as bank and title fees, but cannot be used to fund recurring expenses such as interest or property tax. 

Advantages and Disadvantages of Negative Points

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 — many mortgages with negative points will carry a higher rate of interest over the life of the loan. If, on the other hand, the borrower intends to hold the mortgage for an extended period, it is probably 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 with a 20% down payment of $200,000. 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. 

Special Considerations

Some mortgage brokers may not tell consumers about the availability of negative point loans and might be more concerned about their commission on the deal. In the past, brokers have been known to markup mortgages and keep the amount generated from negative points as compensation for brokering the loan.

Researchers have found that the markups earned by mortgage brokers were persistently higher on negative point loans than on positive point loans. A study conducted by The Mortgage Professor at the turn of the century found that on loans quoted by the lender at 6% plus 3 points, the markup to the borrower was 1 percentage point. But, on loans that were quoted at 7% and minus 2.25 points, the broker's markup was 2.375 points.

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.