A quick overview of three key mortgage lending terms: interest rate, APR and points.
When shopping for a mortgage, you’ll encounter several terms related to interest. For many–especially first-time homebuyers—these terms may be unfamiliar. Here’s a quick overview of what lenders mean when talking about the interest rate, APR and points.
Why are two rates listed for mortgages?
When shopping for a mortgage, you’ll see two rates listed, the interest rate and the APR or annual percentage rate.
The interest rate is the cost of borrowing the principal loan amount. On a fixed-rate mortgage, the interest rate stays the same for the length of the loan. An adjustable-rate mortgage (ARM) is what it sounds like; the interest rate changes over the life of the loan. An ARM offers lower rates than fixed-rate loans for an initial period and then, at a pre-determined time, the rate is adjusted up or down in relation to an index rate.
The APR will always be a bit higher than the interest rate. Why? The APR accounts for the interest rate plus other charges associated with the loan, including points and fees. It gives borrowers a comprehensive way to compare total loan costs.
What are points?
Mortgage points are often called prepaid interest or discount points. They’re used by homebuyers to reduce the home loan’s interest rate. Points can be paid either in cash when you sign the loan papers or rolled into the loan.
Points are optional; you’re not required to buy them. However, many homebuyers do so in order to get lower interest rate for the life of the loan.
(Note: Discount points are not the same as origination points charged by some lenders to process a home loan.)
Who pays for points?
In most cases, the homebuyer pays for points; after all, it’s their loan. However, in a buyer’s market a seller may be amenable to covering the cost for one or more points in order to make the sale.
What’s the dollar value of mortgage points?
Typically, the cost of one point is equal to 1% of the loan principal. This means for a $300,000 loan, one point would cost $3,000.
Each point purchased reduces the loans interest rate by .25 percentage points. For example, on a loan with an interest rate of 6.50%, buying one point brings the rate down to 6.25%. Buying two points brings the rate down to 6.0%
When does it make sense to pay points?
If you plan to move within a few years, points may not be worthwhile. However, if you plan to be in your home longer than the break-even point, mortgage points can help lower your overall interest expense.
Here’s how to calculate the break-even point:
- Using a mortgage calculator, calculate the monthly payment for the loan two ways: with and without paying points
- Monthly payment without points – Monthly payment with points = Monthly savings
- Point cost ÷ Monthly savings = Number of months to break even
- Number of months to break even ÷ 12 = Number of years to break even
Get your home loan questions answered
You don’t have navigate mortgages by yourself! Our team of experts can help you guide your home financing journey and answer all your home loan questions. Contact a Consumers Mortgage Loan Officer in your town online or call us at 800.991.2221.
All loans subject to approval. Rates, terms, and conditions are subject to change may vary based on credit worthiness, qualifications, and collateral conditions.