The relationship, between mortgage rates and fees is direct meaning you have the option to pay fees in exchange for a rate. This is commonly referred to as “buying your rate down” or “paying points.”
Lets go over these terms and discuss how to understand loan quotes as when it benefits you to buy down your rate.
Basics of a rate quote
A mortgage rate quote consists of both rates and fees. Initially, you might receive quotes through forms or emails. Eventually, the quote will be formalized into a federally required document known as a Loan Estimate once you’ve completed a full loan application.
Your loan quote will provide details about the type of loan you’re receiving (such as fixed or adjustable) your specific interest rate’s the cost associated with that rate.
The loan quote must always include the percentage rate (APR) which helps determine the cost of borrowing. As a rule, if the APR is 0.125 percent higher than the quoted rate then the fees are considered customary. If the APR exceeds 0.125 percent higher than the quoted rate then it suggests that the fees are higher, than normal and may involve buying down your interest rate.
Regardless of the situation it is important to request a breakdown of fees.
When you “buy your rate down” or “pay points ” it means you are paying a fee to secure an interest rate. This fee is often referred to as an origination fee or points, on your loan quote. It is calculated as a percentage of your loan amount. Is separate from standard fees like appraisal, credit report, underwriting and title insurance (more information on locating these fees in quotes will be provided below).
Sometimes you may receive a quote that offers two options; one with points and one without points. For instance, if you were applying for a 30-year fixed loan amounting to $300,000, the quote without points might indicate an interest rate of 4.25 percent while the quote with 1 percent in points might show an interest rate of 4 percent.
In this example, the points would amount to $3,000 since they are equivalent to 1 percent of the loan amount. It’s important to note that this $3,000 is in addition to all fees.
By paying these points upfront your interest rate would decrease by 25 percent. As a result, your monthly payment would decrease by $44 and your overall interest cost would be reduced by $62.50, per month.
Is it worth it to pay points and lower your interest rate?
To decide if it’s beneficial to buy down your rate by paying points you need to calculate how long it will take for the savings, on your interest costs to cover the cost of those points.
For instance, let’s say you spend $3,000 on points that result in $62.50 of interest cost savings. By dividing $3,000 by $62.50 we find that it takes 48 months or four years for the interest cost savings to repay the points.
Having a four-year breakeven period means you’ll have years left to enjoy the benefits of the interest rate after recovering the initial cost.
On the other hand, if you had a period of four years on a 5 year ARM loan you’d only have one year of advantage from the lower rate before the loan adjusts.
Calculating this breakeven point is crucial for determining whether buying down your rate is a choice.
Typically paying 1 percent of your loan amount in points can reduce your rate by 0.25 percent. However, keep in mind that this may not always be true. It’s advisable to ask your lender about options, for paying points or lowering your rate so that you can analyze scenarios and determine favorable breakeven timelines.
To obtain and review loan quotes you need to provide six details as defined by the law;
1. Name
2. Property address
3. Estimated value of the home
4. Income information
5. Desired loan amount
6. Social Security number (required for credit score assessment)
Once you have submitted your loan application your lender is obligated to provide you with a Loan Estimate document within three days.
On page 2 of the Loan Estimate, you will find a section called “Loan Costs” in the corner. This section displays the percentage of the loan amount associated with any quoted points along, with their corresponding dollar amounts.
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