Understanding mortgage interest rates and points
When you're ready to shop for a home mortgage, you'll need to understand interest rates and points. Learn how these options work before making a decision.
Some lenders have multiple rates available for each type of mortgage. To effectively shop around for a mortgage, you'll need to understand interest rates and points.
Video Transcript: Understanding mortgage interest rates and points
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Interest rates explained: Elapsed time 0 minutes 0 seconds
Mortgage interest rates and points can be a lot to digest! You should know, just about every lender has a variety of interest rates available to you. Let's learn why and find out how you can use interest rates and points to your advantage.
Think of interest as the price you pay for using someone else's money until you pay it back. The rate of the interest you will have to pay, depends a lot on the market.
Ways to lower your interest rates: Elapsed time 0 minutes 28 seconds [00:28]
There are ways you can lower your interest rate and reduce your total payments, including making a larger down payment, choosing a shorter loan term and boosting your credit score.
Points are a way for the lender to provide more interest rate options to the borrower to fit your specific situation better. They come in two forms: origination and discount points.
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Origination fees are points paid to the lender at closing and used to cover the costs of processing the loan.
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Discount points are fees that allow you to buy down your interest rate, therefore lowering your monthly payment.
Buying points may give you a tax benefit, but you should contact a tax professional for your specific tax situation.
Although discount points can buy a lower interest rate, it may take some time to see the benefit. One point is worth 1% of your loan amount.
Let's say you're borrowing $100,000 and by paying one point — or $1,000 -- you can lower your monthly payment by $50. To figure your breakeven, you divide $1,000 by $50, which means you'd have to hold the mortgage for 20 months to recoup the 1 point you paid for a lower interest rate.
To decide if points are right for you, make sure you have enough cash on hand for other closing costs, move-in expenses and general emergencies. Also consider using any excess cash toward a larger down payment or for other financial goals, instead of paying points.
As always, crunching the numbers is easier with help.
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Interest rates
Think of interest as the price you pay for using someone else's money until you pay it back. The price you pay depends on:
- How much you put down. A larger down payment reduces the risk for the lender and can get you a lower rate. It's important to have a good idea of what will be your down payment.
- How long you'll be borrowing the money. Generally, the longer the mortgage, the higher the interest rate.
- The likelihood that you'll pay it all back. Lenders gauge this by checking your credit history and credit score. Lower-risk borrowers pay lower rates.
- How long the rate is guaranteed for. The rate on a fixed-rate mortgage is usually higher than the initial rate on an adjustable-rate mortgage.
- Whether you'll live at the house or rent it out.
- Whether you're buying or refinancing.
Discount points and lender credits
Consider ways to lower your loan rate or reduce your upfront costs.
- Discount points can be paid in exchange for a lower interest rate on the mortgage. Each point is equal to 1% of the amount you're borrowing. For example, 1 point on a $200,000 loan would be $2,000.
- Lender credits work like discount points, but in reverse. They are intended to cover part or all the borrower's closings costs, in exchange for a higher interest rate.
Discount point decisions
It's one of the trickier decisions you'll face when choosing a mortgage: Pay discount points at closing to reduce the interest rate or elect to pay a higher interest rate over the term of the loan?
Before we get into the math, consider one basic, underlying principle: The longer you'll stay in the same house with the same mortgage, the more value you'll get from a reduced interest rate. Leave the home or refinance the original mortgage too soon, and you could come out behind.
To crunch the numbers, first figure out the difference in payments with and without paying the points. Next, divide the amount you'd pay in points by the monthly savings. The result will be the number of months for you to break even on your investment in points.
For example, let's say you're borrowing $150,000 and, by paying two points — or $3,000 — you can lower your monthly payment by $50. To figure your breakeven, you divide $3,000 by $50, which means you'd have to hold the mortgage for 60 months to recoup what you paid to the lender for a lower interest rate.
In addition to considering your break-even period, you'll also want to make sure that, after paying points, you'll still have enough cash on hand for other closing costs, move-in expenses and general emergencies. One other consideration regarding paying points is that the IRS considers discount points to be a form of interest, so they're generally tax-deductible if you itemize your deductions. The 2018 Tax Reform Act put limits on mortgage interest and points deductibility, so be sure to consult your tax advisor regarding your personal situation.
You should also consider that, instead of using funds to pay points, any excess cash you have could be used for a larger down payment or other financial goals like retirement or college savings.
On the other hand, if you're tight on funds for closing costs or a down payment but can afford a higher monthly mortgage payment long term, you can have the lender pay you lender credits at closing in exchange for a slightly higher rate. Lender credits are intended to give the borrower greater flexibility to make the mortgage deal work for their financial situation. This may make sense if you need additional cash for closing costs or don't plan on being in the home very long. The credit from the lender has to be part of the mortgage transaction. If the money isn't put toward closing costs, any unused portion of the credit is lost.
The USAA Advice Center provides general advice, tools and resources to guide your journey. Content may mention products, features or services that USAA Federal Savings Bank does not offer. The information contained is provided for informational purposes only and is not intended to represent any endorsement, expressed or implied, by USAA or any affiliates. All information provided is subject to change without notice.
