Mortgage Points and Lender Credits

The interest rate is a major part of any mortgage, but buyers also need to understand points and lender credits. Both change the tradeoff between cash needed at closing and the cost of the loan over time.

Mortgage points let a borrower pay more upfront for a lower interest rate. Lender credits reduce closing costs, though the borrower accepts a higher interest rate. Neither option works best for every buyer. The right choice depends on available savings, the monthly budget, and how long the borrower expects to keep the mortgage.

Mortgage points are also called discount points. One point equals 1 percent of the loan amount. It does not mean the interest rate drops by 1 percentage point.

A buyer taking out a $300,000 mortgage would pay $3,000 for one point. Two points would cost $6,000. That money becomes part of the closing costs, along with lender fees, title charges, appraisal costs, prepaid taxes, and insurance.

In exchange, the lender offers a lower rate. The rate reduction does not follow a fixed formula. One lender may reduce the rate by 0.25 percentage points for one point. Another lender may offer a smaller or larger reduction for the same cost.

For example, a lender may offer a 30-year fixed mortgage at 6.5 percent with no points. The same lender could offer 6.25 percent if the buyer pays one point. The lower rate reduces the monthly principal-and-interest payment for as long as the borrower keeps that mortgage.

Points only save money after the buyer recovers the upfront fee through lower payments. This is the break-even point. To find it, divide the cost of the points by the monthly savings.

If a buyer pays $3,000 for a lower rate and saves $100 per month, the break-even point is 30 months. A buyer who keeps the mortgage longer than 30 months can begin saving money. A buyer who sells or refinances before then may lose money on the points.

Future plans matter. Someone who expects to stay in the home and keep the same loan for ten years may find points useful. Someone planning to move in three years may prefer to keep closing costs lower.

Points can also help buyers who want the smallest possible monthly payment. Paying more at closing may leave a borrower with a lower payment every month. This can help with long-term budgeting, provided the buyer still keeps enough savings after closing.

A lower rate should not empty a buyer’s bank account. Homeownership can bring moving costs, repairs, furniture purchases, property taxes, insurance increases, car repairs, and emergencies. Keeping a cash reserve may matter more than reducing the rate by a small amount.

The word points can describe more than one charge. Discount points buy down the interest rate. Origination points are lender fees for making or processing the loan. Buyers should make sure they know which kind of point appears in their loan documents.

The Loan Estimate lists the mortgage rate, projected payment, closing costs, discount points, and lender credits. Lenders generally provide it within three business days of an application. Buyers can request Loan Estimates at several rate levels and compare them side by side.

Lender credits work in the opposite direction. The borrower takes a higher interest rate, and the lender provides money to offset closing costs. The credit reduces the cash required at the closing table. It does not create free money.

A lender might offer a 6.5 percent loan with no points or credits. The borrower may instead choose a 6.75 percent rate with a $3,000 lender credit. The buyer brings $3,000 less to closing, then pays more each month because the rate is higher.

Lender credits can help buyers with limited cash. Closing costs may include an appraisal, title insurance, lender charges, prepaid taxes, homeowners insurance, and other fees. Those expenses can total thousands of dollars. A credit can let a buyer close while preserving money for moving or repairs.

They can also suit a buyer who plans to sell soon. A borrower expecting to move in a few years may prefer lower upfront costs, even if the monthly payment is higher. The borrower may not keep the loan long enough for the higher rate to become more expensive than the closing costs saved.

The tradeoff reverses for a buyer who keeps the mortgage for many years. The credit might save $3,000 at closing. The higher interest rate can cost far more than $3,000 over a long loan term. Buyers should ask for the payment difference and calculate how long it takes for the higher monthly cost to exceed the credit.

A lender can present several rate options for the same loan amount. For example:

• 6.25 percent with $3,000 in discount points

• 6.5 percent with no discount points or lender credit

• 6.75 percent with a $3,000 lender credit

The buyer should compare total cash needed at closing, the full monthly payment, and how long they expect to hold the loan. The lowest rate may not fit a buyer short on cash. The highest rate may not make sense for someone planning to keep the mortgage for decades.

Refinancing can change the calculation. A borrower who accepts lender credits and refinances after a few years may not pay the higher rate for long. A borrower who buys points and refinances quickly may never recover the upfront cost. Refinancing also requires approval and closing costs, so it should never be treated as certain.

Buyers should ask each lender for several written options. One Loan Estimate can show a loan with points, another can show the same loan with no points, and a third can show lender credits. Comparing the documents shows the real cost of each choice.

Mortgage points and lender credits give borrowers control over when they pay for financing. Points raise closing costs and lower the rate. Lender credits lower closing costs and raise the rate. The useful choice depends on cash available now, the monthly payment the buyer can manage, and the likely life of the mortgage.