Interest Rates, Mortgage Points, and Fees

A mortgage is a loan used to finance the purchase of real property. A mortgage consists of several important variables, such as mortgage points, the interest rate, down payment and closing costs. These factors determine the monthly payment as well as how much the borrower will pay over the life of the loan. You should also beware of any interest that is tax deductible.

Interest Rates

For home buyers, shopping for a home loan can be confusing because mortgages differ depending on the lender. Interest rates tend to change daily, depending on the type of mortgage you have, an adjustable-rate mortgage or fixed-rate mortgage. The interest rate on a mortgage is the rate the lender charges for borrowing the money for the loan term. The rate varies depending on factors like the borrower's credit score and economic conditions such as inflation, housing prices, and the demand for mortgages.

Mortgage Discount Points

Mortgage points are a type of fee paid by the borrower to reduce the interest rate. A borrower can buy mortgage points, an upfront cost, one-time lump sum payment in exchange for a lower mortgage interest rate. This is known as buying points or rate reduction. One point, for example, is equivalent to 1% percent of the mortgage amount. For a $100,000 mortgage, one point is equal to $1,000. In general, the more points a borrower pays, the lower the interest rate. Points usually range from 0% to 3%.

Fees

Different lenders charge various settlement fees for a mortgage. Typical upfront fees include:

• Application fee
• Loan origination fee
• Appraisal fee
• Home inspection fee
• FHA, VA, and RHS fees
• Flood determination fee

Since the amounts of the fees vary from lender to lender, shopping around for the most competitive mortgage will help reduce these fees.

Annual Percentage Rate

Federal law requires that mortgage lenders disclose the annual percentage rate, or the APR. The APR is the annual cost of the mortgage loan. The calculation of the APR includes interest, mortgage insurance (PMI), and fees. included in your monthly mortgage payments. A loan with a lower APR may indicate a better value than one with a higher APR. However, since lenders make these calculations differently, it may be an unreliable indicator of the better loan. APRs are a less important way to assess the total loan amount for a borrower that intends to pay off the loan early by refinancing or selling the property prior to the full term of the mortgage.

Paying Mortgage Points vs. a Higher Interest Rate

Paying mortgage points for a lower interest rate is not advantageous in every situation. Consider the following when deciding whether to pay more points or a higher interest rate.

• How long will you stay in the home? A buyer that plans to own the property for a long time will benefit from the lower interest rate. Plans to sell or refinance the home within a short time will give the buyer less benefit from the lower interest rate.
• Will you break even? In order to break even, a homeowner must stay in the home and continue making mortgage payments for a certain amount of time. Consider whether you will stay in the home long enough to benefit from the cost of buying the point.
• Can you afford to pay mortgage points at closing? The more points you have, the more cash you will need at the real estate loan closing. Consider whether you have enough cash to pay for the points.