Interest Rates, Mortgage Points, and Fees

A mortgage is a loan used to finance the purchase of real property. Taking out a mortgage may be the most important financial decision of your life, especially if you're buying a new home for the first time.

A mortgage consists of several important variables, such as mortgage points, interest rates, down payments, 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.

What Are Interest Rates?

Like credit cards, mortgage loans have interest rates. 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. For example, a higher credit score typically gives you a reduced interest rate to save you money.

For home buyers, shopping for a home loan can be confusing because interest rates differ depending on the lender. Interest rates also tend to change daily, depending on the type of mortgage you have, an adjustable-rate mortgage or fixed-rate mortgage. A lower interest rate can give you significant monthly savings on your mortgage payments.

What Are Mortgage Discount Points?

Mortgage points are a 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. The example below helps to demonstrate how mortgage points work:

One point 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%.

Disclaimer: This is not to be confused with mortgage origination points, which borrowers pay for the cost of mortgage processing and evaluation.

What Types of Fees Are Part of a Mortgage?

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 (these are various government agency fees)
• Flood determination fee

Since the fees vary from lender to lender, shopping around for the most competitive loan estimate will help reduce these fees. You can also ask your loan officer to explain the costs you will incur during the life of your loan. They can give you information on how quickly you'll be able to build home equity.

What Is the Annual Percentage Rate (APR)?

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 who 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. Sometimes, a point costs you more in the long run. 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. A refinance may have a break-even point at which the buyer will start saving money in comparison to the terms of the first mortgage.
• Will you break even? 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.

You may also want to consider a mortgage buy down. A buy down allows you to pay an upfront fee to reduce your interest rate for the first few years of your mortgage.

Contact a Lawyer To Learn More About Mortgage Costs

If you need clarification on what kinds of financial responsibilities you can expect from your mortgage, you may need legal aid. An experienced real estate attorney can help you break down all the components of your mortgage. They can review a loan estimate and help you save money by advising you on different areas to focus on.