I Turned Down the Lowest Rates I've Seen in Years: The Four Factors of a Real Estate Loan
TLDRI turned down a 5.75% loan and took a higher rate instead. Interest is only one of four factors. Points, fees, and prepayment penalties can make a “great rate” cost more over your actual hold period than a higher rate with cleaner terms. Figure your break-even. That is the real answer.
Table of Contents
- The Four Factors
- How Amortization Hides the Real Cost
- Points on the Front vs Prepayment on the Back
- Fees Are Where They Get You
- Most Flippers Do Not Hold 30 Years
- Cash-Out Refinance Is Tax-Free
- FAQ
- Related
The Four Factors
Everybody is hung up on the interest rate. Jerome Powell, the Fed, the news cycle, the freakouts. Interest matters, but not as much as you think. There are four factors that decide what a loan actually costs you.
- Interest rate
- Points on the front end
- Fees on the front end
- Prepayment penalty on the back end
Most lenders play with all four, and they know that if they give you a headline number on one you will stop paying attention to the other three. That is how a 5.75% rate ends up costing more than a higher rate over the life of the loan.
The headline rate is marketing. The four factors together are the loan.
How Amortization Hides the Real Cost
Let me walk you through a $200,000 loan at 12% just to make the math easy. Twelve percent per year is 1% per month. On $200,000 that is $2,000 a month in interest if it were interest-only.
Most long-term loans, including all 30-year fixed loans, are amortized. Your payment stays the same every month, but the split between interest and principal shifts over time. In the early years, you pay mostly interest. In the later years, you pay mostly principal.
| Year of Loan | Interest Share of Payment | Principal Share of Payment |
|---|---|---|
| Year 1 | High | Low |
| Year 10 | Balanced | Balanced |
| Year 25 | Low | High |
This matters because if you sell or refinance in the first five years, you have paid almost no principal down. The lender made their money on interest up front, and you walk away with almost the same balance you started with.
Pro TipIf you know you are going to refinance every four or five years, factor in how little principal you will have paid down. Your decisions about rate and fees should be based on the years you will actually hold the loan, not the 30 years on the paper.
Points on the Front vs Prepayment on the Back
Points and prepayment penalties are the two levers lenders use to front-load or back-load their money.
Points are paid at closing. Two points on a $200,000 loan is $4,000 up front. The lender gets their money on day one regardless of what happens after.
Prepayment penalty, often called PPP, is paid if you exit the loan early. A typical step-down looks like 5-4-3-2-1. Sell or refinance in year one, you pay 5 points. Year two, 4 points. All the way down to zero after year five.
On the same $200,000 loan, year one exit costs you $10,000 in prepayment. That makes a 5.75% rate with a 5-year PPP and 2.5 points on the front end very expensive if you know you are selling in year two.
Common MistakeFocusing on the rate and ignoring the prepayment. A 5.75% rate with a 5-year PPP and 2.5 points on the front is usually worse for a flipper than a 7% rate with no points and no prepayment. The math depends on your hold period.
Fees Are Where They Get You
Fees are the third factor and they are the hardest to pin down because lenders get creative.
The main categories:
- Origination fee
- Lender fee, especially when a broker is involved
- Appraisal fee
- Inspection fees (mostly on hard money loans)
- Miscellaneous junk fees
I got burned once. A lender had me pay appraisal fees for two new builds I was doing. The fees felt high but I was already deep with the lender so I paid them. Never heard from the lender again after I paid. He was likely taking a cut over the top of the appraisals and that was his payday.
On a purchase or refinance, long-term fixed-rate lenders usually sell the loan immediately after closing, so they make money on origination and the first few months of interest. They are incentivized to load up the front.
Ask for Every FeeEvery lender call, ask the same question: “Literally tell me exactly how much I will be paying you.” Origination, lender fee, appraisal, inspections, anything. Get the full number in writing. The surprise fees at closing are where most people get hurt.
Most Flippers Do Not Hold 30 Years
Here is the reality that changes every loan decision.
Most mortgages on personal residences are refinanced or paid off within five years. Rental property investors often refinance on a similar cadence. You are not going to hold this 30-year loan for 30 years. You are going to refinance it when the value grows and you can pull cash out, or when rates drop and you can recast cheaper, or when you sell the property entirely.
That changes the math on points, fees, and prepayment. If you know you are going to exit at year four, the question is not “which loan has the lowest rate over 30 years” but “which loan costs the least over four years.”
| Hold Period | What Matters Most |
|---|---|
| 1-2 years | Avoid prepayment penalty, minimize fees and points |
| 3-5 years | Balance rate against fees and points |
| 10+ years | Rate dominates, fees amortize away |
Calculate your break-even. If Option A has a 6.5% rate with no points, and Option B has a 5.75% rate with 2 points, compare total cost over your planned hold period, not over 30 years.
Key ConceptThe break-even point is the month when the cumulative cost of Option A and Option B cross. Before break-even, the lower-fee loan wins. After break-even, the lower-rate loan wins. If your planned hold is shorter than break-even, take the lower-fee loan. If it is longer, take the lower-rate loan.
Cash-Out Refinance Is Tax-Free
The reason refinance planning matters so much: a cash-out refinance is debt, not income. Debt is not taxed.
You keep a property, build equity through forced appreciation and market appreciation, then refinance at 80% of the new value. If the new value is $250,000 and you owed $160,000, the bank gives you $40,000 in cash. That $40,000 hits your bank account tax-free because it is borrowed money, not earned income.
Extend the pattern across multiple rentals and you have a tax-free income stream that flippers use to pay zero in income tax while still living well. Full breakdown in How Real Estate Makes You Wealthy While Paying Zero Taxes.
Understand the loan, plan the refinance, extract the tax-free cash.
FAQ
Why did you turn down 5.75%?
Because it came with 2.5 points on the front and a 5-year prepayment penalty. On my hold period, probably four to five years, the all-in cost was worse than a 6.5% loan with no points and no prepayment. The headline rate was not the answer.
I am just starting out. How do I know how long I will hold a loan?
Think about the property and your plan. A flip is usually 6 to 12 months, so short-term hard money is the right product. A BRRR is usually 4 to 5 years between refinances. A long-term rental you plan to keep forever is 7 to 10 years until the next refinance. Match the loan to the plan.
What is a reasonable number of points to pay?
Depends on the rate trade. Each point typically buys down the rate by 0.25% on a conventional loan. If you will hold long enough to recoup the point through lower payments, it is worth it. If not, skip the points.
Do all lenders have prepayment penalties?
No. Many conventional long-term mortgages have no prepayment penalty. Some investor loans and most hard money loans do. Always ask, and always get it in writing.
What should I do when I compare two loan options?
List all four factors for each option. Compute the total cost over your planned hold period. Include upfront points, all fees, monthly interest, and any prepayment penalty if you exit during the PPP window. Whichever has the lower total wins, regardless of which one has the lower rate.