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, and fees. These factors determine the mortgage payment as well as how much the borrower will pay over the life of the loan.
Shopping for a home loan can be confusing because mortgages differ depending on the lender and interest rates tend to change daily. The interest rate on a mortgage is the rate the lender charges for borrowing the money. The rate varies depending on factors like the borrower's credit history and economic conditions such as inflation, housing prices, and the demand for mortgages.
Mortgage points are a type of fee paid by the borrower to reduce the interest rate. A borrower makes a one-time lump sum payment in exchange for a lower interest rate. 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%.
Different lenders charge various settlement fees for a mortgage. Typical 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. The calculation of the APR includes interest, mortgage insurance, and fees. 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 a loan 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 buyer 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 loan closing. Consider whether you have enough cash to pay for the points.