If you are in the process of buying a home or refinancing an existing mortgage, you’ve probably heard the terms points and credits. Simply put, points and lender credits allow you to make tradeoffs in how you pay for your closing costs and mortgage.
Points, or discount points, lower your lifetime interest rate when you pay an upfront fee at closing. On the other hand, lender credits will lower your upfront closing costs (or eliminate them entirely) — but you have to accept a higher interest rate.
Here, we’ll take a closer look at discount points and lender credits, how they work, and how to decide if they’re right for you.
Points, also referred to as discount points, equate to a one-time fee paid in addition to your other closing costs that will allow you to get a lower interest rate. Essentially, paying for points allows you to make a trade-off between your initial closing costs and your monthly mortgage payments — your upfront costs will be higher at closing, but paying for discount points allows you to take advantage of a lower interest rate, which translates to lower monthly payments (and a lower overall payout over the life of the loan). If you know that you will keep your loan for a long time, discount points may be a great choice for you.
Discount points are calculated based on the amount of your loan. Each point is equivalent to one percent of the loan amount. In other words, one point on a $500,000 loan would be $5,000, two points would be $10,000, and so on. And points don’t have to be purchased as a whole number, so you could pay for any number of points you like. These points are paid at closing and get added in with your other closing costs.
Paying for points will lower your interest rate in relation to a zero-point loan you would get from the same lender. The more points you purchase, the lower your interest rate should be. In other words, a loan with two points should have a lower interest rate than a loan with one point, assuming that both loans are through the same lender and are the same type of loan (e.g., type of loan, loan term, down payment amount, etc).
The exact amount that points will lower your interest rate is determined by a number of factors, including your lender, the type of loan you choose, and the overall lending market. It’s also important to keep in mind that rates can vary by lender, so it is possible that one lender’s one-point loan may still have a higher interest rate than a zero-point loan with a different lender. You should always shop carefully for your loan and choose your lender carefully.
Lender credits work in a similar fashion as discount credits — but in reverse. Rather than paying more up front for a lower interest loan, with lender credits, you agree to pay a higher interest rate in exchange for the lender giving you funds to offset your closing costs. When receiving lender credits, you will pay less in closing costs, but you will end up paying more over the lifetime of the loan because of the higher interest rate. If you don’t plan on keeping the loan for a long time, receiving lender credits can be an efficient way to lower your upfront costs at closing.
Again, the exact increase to your interest rate will depend on a number of factors, including your lender, the type of loan you choose, and the overall market. Sometimes, you may receive a large credit in exchange for each increase in your interest rate. Other times, the credits may be smaller.
Each lender has their own unique pricing structure, so loan credits will vary from lender to lender. This means that a loan with a one-percent lender credit with one lender may or may not have a higher interest rate than the same loan with a different lender.
How to Choose Between Discount Points or Lender Credits
As with many other decisions you make throughout the course of purchasing a home or refinancing a mortgage, the choice between discount points or lender credits will depend on your own personal situation. When trying to decide if points or credits are right for you, ask yourself one question: how long do you intend to keep the property that you are purchasing or refinancing?
As with many decisions and choices, there is a break-even point at which it makes sense to go with one choice over another. On average, most American homeowners will sell or refinance within 13 years of obtaining their loan. If you are in this majority, it may make more sense to go with credits. The upfront savings will be more than any potential savings you may miss out on down the road.
On the other hand, if you know that you will keep your loan for a longer period of time, discount points may make more sense. Even though you pay more at closing, you will save more over the lifetime of your loan by making lower monthly payments.
At Reali Loans, we offer lower rates, faster closings, and happier homeowners. Our average loans customer will save $20,000 over the life of their loan versus our competitors. Learn more finding the best home loan today.
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