How Mortgage Points Work
- January 10, 2020
If you’ve started to shop around for a mortgage then you’ve probably noticed that each interest rate comes with “mortgage points”. It’ll be a number that’s either in decimal or percentage format. Sometimes you’ll even see a lender say this interest rate comes with 1 point in fees. The varying differences and confusing terminology is enough to make your head spin. It’s important that you understand how mortgage points work because they are a component of the total cost of a mortgage. Let’s start with a mortgage points definition and then we can talk about how mortgage points work.
Mortgage Points Definition
Mortgage points are fees your lender charges based on the interest rate you select. They are also known as discount points because you are essentially discounting or lowering your interest rate by paying mortgage points. The more mortgage points you pay, the lower your interest rate will be.
The basic math is that 1 point = 1% (.01) of your loan amount. For example, if you’re borrowing $300,000 and the interest rate you chose has 1 point in fees then your lender fees will equal $3,000 (.01 x $300,000).
This can also work for fractions of a point and decimal form. For example, 0.75 points or three quarters (¾) of a point equals 0.75% of your loan amount in fees (that’s $2,250 on a $300,000 loan amount).
What are negative mortgage points?
It is also possible to have negative mortgage points associated with an interest rate. This is known as a credit. For example, on a $300,000 loan with -0.47 mortgage points you’ll multiply the loan amount by -0.47% and get a $1,410 credit. Any lender credits at closing can be used to offset the remaining costs on your loan. You can get a credit if you choose a higher interest rate where you are no longer paying for a discount.
Hidden Mortgage Fees
The best shopping experience is to show you the mortgage points in dollars instead of a percentage since that’s the bottom line. You’ll also want to check the fine print for any additional lender fees or hidden mortgage fees. These will show up with various labels like “Underwriting Fee”, “Administrative Fee”, “Processing Fee”, etc. This amount is always a fixed dollar amount and doesn’t vary with your loan amount, like the mortgage points.
There are no hidden mortgage fees on Achroma’s site. All of the mortgage fees or (credits) you see on Achroma’s site are fully inclusive of the mortgage points associated with the interest rate shown and the fixed dollar fee from the lender. Showing this upfront with no hidden mortgage fees in the fine print is part of Achroma’s fair lending policy and bias-free commitment.
How Mortgage Points Work
Every interest rate that a lender offers comes with a price that the lender represents with mortgage points. Interest rates are typically offered in ⅛ increments (i.e. 3.5%, 3.625%, 3.75%), although Achroma can customize your loan with any interest rate. As your interest rate goes up or down by ⅛ then your points will shift as well. Reducing your interest rate leads to more points and increasing your interest rate leads to less.
Even though the change in the interest rate is incremental, the change in points is not. What do I mean by this? Let’s take a look at the table below:
|Interest Rate||Mortgage Points||Difference in Mortgage Points||Lender Fees or (Credits)1|
The “Difference in Points” column shows the change in mortgage points between interest rates isn’t always the same. If you choose a higher interest rate with less mortgage points then you’ll be offsetting upfront costs for more interest payments over the life of the loan. A reversal of this logic applies if you pay more mortgage points to discount your interest rate in that you’ll pay more in upfront costs but less over the life of the loan.
How to shop for a mortgage
If a lender quotes you an interest rate you should always ask for a quote above and below that interest rate. For example, if you get quoted 3.625% and 0.71 points then ask for the mortgage points associated with 3.5% and 3.75%. If you think the difference in cost in mortgage points is affordable and want to hear more then ask for 3.875% and 3.375%. This way you have a bevy of options, similar to the table above, to compare with other lenders when shopping around.
Now that you’ve gathered several combinations of interest rates and mortgage points you need to determine which one is best for you. While we demonstrated that the change in mortgage points is not incremental like the change in interest rates, higher interest rates are usually associated with less fees (or larger credits). A simple table like the one below makes it easy to determine the best option:
|Interest Rate||Lender Fees or (Credits)1||Interest Paid in the first 7 Years||Total Costs|
What interest rate is best for me?
First, determine how long you plan to stay in this home (or keep this mortgage). In the example above we used seven years. Next, figure out how much interest you’ll pay during that time (use an amortization schedule online) and add that to the mortgage points. This is your total cost for the loan over that time period. You can repeat this calculation for each interest rate/fee combo and that’ll tell you which loan is the cheapest for your situation.
Typically, the longer you stay in the home, the more beneficial it is to pay more mortgage points for a lower interest rate. In the example above, choosing an interest rate of 3.375% would be cheapest in the long run. That being said, cash needed to close is another consideration. If you can only afford to bring a certain amount of money to the closing then your options will be limited by that amount. You might not be able to discount your interest rate as much as you would like.
Even if you plan on staying in the house forever, buying down your interest rate with more fees might not be feasible if you don’t have the money to do so.