Shopping for a mortgage is just as hard as shopping for a home. You have to shop around for the best mortgage rates, comparing offers, and find which deal works best for your unique situation.
It’s not always so cut and dry – there are a lot of different factors that affect the price of a loan. Two of the most popular methods are with points and lender credits. Before buying mortgage points or lender credits, it’s essential to understand the differences between each, how they work, and how long it takes to benefit from the upfront costs.
What Are Points on Your Loan Estimate?
Points let you make a tradeoff between your upfront costs and your monthly payment. By paying points, you pay more upfront, but in turn, you receive a lower interest rate and therefore pay less over time.
It’s important to know that the interest rate reduction that you receive for buying points depends on the lender and the current marketplace.
Mortgage points are optional, paid for upfront, and lower your interest rate.
What is a Credit on Your Loan Estimate?
Credit works the same way as points, but in reverse. You pay a higher interest rate, and the lender gives you money to offset your closing costs. When you receive lender credits, you pay less upfront, but you pay more over time with the higher interest rate.
Similar to points, credits are also optional but are paid off throughout the life of the loan, and rather than lower the interest rate, they lower the upfront payment.
How Are Points and Credits Calculated?
Points and credits are calculated as a percent of the total loan amount. Each point and credit are equal to 1% of the mortgage amount.
To make things a little easier to understand, here is an example of how to calculate points.
If your loan amount is $100,000, 1 point = 1% of the loan value, which is $1,000 ($100,000*1%=$1,000). So if you get 1 point added to your loan, you would have to pay $1,000 more upfront but your interest rate would actually decrease, typically by 0.25% per point.
So if the interest rate on your loan was 4.5% and you bought a point, the interest rate could be lowered to 4.25% for the lifespan of your loan.
Here is an example of how to calculate credits.
Again, 1 credit is also equal to 1% but they increase monthly payments. If the value of your loan is $250,000 and you purchase 1 credit, you will receive $2,500 ($250,000*1%= $2,500) of your loan upfront to put towards closing costs.
Don’t forget credits are the opposite of points. Since you are taking an advance on your loan ahead of time it actually increases the interest rate to offset the difference. If the interest rate on your mortgage was 4.5% and you bought a credit, it might now increase the interest rate to 4.75% (and the monthly payments) for the life of your loan.
How Points Affect Your Loan’s True Cost
If you’re in the position to buy points in addition to the down payment and closing costs, then you’ll lower your monthly payment and save a lot of money on interest. However, the only way to ensure savings is by staying in the home long enough to retrieve the prepaid interest.
For example, if your loan principal is $100,000 and you buy two points for $2,000 upfront, you decrease the interest rate from 4.5% to 4%. With 0 points you would have a monthly payment of $507 with a total interest of $82,407. With $2,000 in points you would receive a monthly mortgage payment of $477 using the 4% rate. This is an interest total of $71,870 and a lifetime savings of $8,537.
You can use our mortgage Points Calculator to determine if using points is right for you.
Choosing Between Points and Credits
Every situation is different. Deciding between points and credits is based on your personal situation and how long you choose to keep the loan. If you plan to live in your home for a long time and can afford it, using points makes the most sense. You’ll experience a lower monthly payment and save money in the long run.
It’s important to remember that using points means you’ll have to pay more money upfront at closing.
If you plan to live there for a short time, lender credits may be more suitable for you. Lender credits can be a huge advantage for homeowners who are short on cash. However, it’s important to remember that lender credits aren’t free money. It still needs to be paid off.
In a nutshell, using points means you pay more at closing to get a lower interest rate. Using credits means you pay less at closing but will get a higher interest rate. At Loan Compass, we specialize in getting our customers the best rates for them.
If you are not sure if you should get points or lender credits on your loan, we recommend speaking with a loan professional to learn more!