Interest Rates Versus Points

Most home buyers are familiar with the interest rates that come with mortgages.  Interest rates for home loans have gotten a lot of attention in the news recently because they’re the lowest they’ve been in decades.  Right now, interest rates are in the five to seven percent range for conventional loans. 

Although borrowers are generally familiar with interest rates, points are not discussed as often.  However, they’re just as important for buying a home.  After all, interest rates aren’t the only way that banks earn their money.  Points are sometimes also called a loan origination fee, which is a more helpful name for discussing how this cost differs from an interest rate.  The interest that you pay on your loan goes directly to the bank for as long as you have the loan – it’s an ongoing payment.  The loan origination fee is a one time fee that you pay before you officially take on your home loan. 

Points and interest rates are given together in the quote that you get from your lender, and they work together on a kind of tradeoff.  The lower the points you pay at closing, the higher the interest rate that you’ll pay over the lifetime of the loan.  So, if a lender quotes you with hardly any points, don’t automatically assume that it’s a better loan.  Often the zero point loans are the most expensive in the long run.  The bank will take your money one way or the other.  You just get to choose how they take it!

In getting to the technical aspect of points, a good general rule of thumb is that one point equals one percent of the loan amount.  For example, let’s say you’re getting a loan for $200,000.  Your lender tells you that your loan will cost 1.5 points.  This cost is equal to 1.5 percent of the loan, or $3,000.

Because interest rates and points are a balancing act – and one that you’re usually in control of – it’s important to talk to your lender about your options.  Many factors will determine which is the best way to pay.  If you have plenty of money saved up for your down payment and closing costs (and if you plan to stay in the home for a long time), it’s generally better to pay higher points upfront and enjoy a lower interest rate.  Be sure to talk to your lender to see which way will save you money in the long run.