At some point, most of us will need to secure a mortgage to finance a home purchase. And when that time comes, you’ll likely come across terms like mortgage points and rebates. But what do they mean, and how do they affect your mortgage?

Mortgage Points

The Consumer Financial Protection Bureau (CFPB) explains that points give you the option to choose between upfront costs and monthly payment. Paying points means paying more upfront but receiving a lower interest rate, leading to lower payments over time. This is a good option for those planning to keep their loan for a long time.

The calculation of points is based on the loan amount, where each point is equivalent to one percent of the loan amount. For instance, on a $100,000 loan, one point would cost $1,000. Points can also be paid in decimals, such as 1.375 points ($1,375) or 0.125 points ($125). These points are paid during closing and will increase your closing costs.

Paying points lowers your interest rate compared to a zero-point loan at the same lender. A loan with one point should have a lower interest rate than a loan with zero points, assuming both loans are the same kind and offered by the same lender. The same kind of loan with the same lender with two points should have an even lower interest rate.

Points are listed on your Loan Estimate and Closing Disclosure on page 2, Section A. By law, points listed on these documents must be connected to a discounted interest rate. However, the exact amount your interest rate is reduced depends on the lender, loan type, and mortgage market conditions.

It’s essential to note that a loan with one point at one lender may not have a lower interest rate than the same kind of loan with zero points at a different lender. Each lender has its own pricing structure, so it’s wise to shop around for your mortgage. Explore current interest rates or learn more about how to shop for a mortgage with the CFPB.

Lender Credits

According to the CFPB, Lender credits operate in reverse to points. You pay a higher interest rate, and the lender gives you money to offset closing costs. It allows you to pay less upfront but more over time.

Lender credits are calculated in the same way as points and may appear as negative points on lenders’ worksheets. For example, a lender credit of $1,000 on a $100,000 loan might be described as negative one point.

The credit offsets your closing costs, resulting in lower payments at closing. However, in return for the lender credit, you pay a higher interest rate than without one.

The increase in your interest rate depends on the lender, loan type, and mortgage market. The amount of lender credit you receive per 0.125% interest rate increase may also vary. Some lenders may offer a large lender credit, while others may offer a smaller one.

It’s important to note that a loan with a one-percent lender credit at one lender may or may not have a higher interest rate than the same kind of loan with no lender credits at a different lender. Each lender has their own pricing structure, and some lenders may be more or less expensive overall than other lenders. Explore current interest rates or learn more about how to shop for a mortgage with the CFPB.

How It Works

Here’s how points and credits work in practice. Suppose you borrow $300,000.00 and qualify for a 30-year fixed-rate loan with an interest rate of 6.000% and zero points. The chart below shows the tradeoffs you can make.

In the first column, paying points reduces your rate, while the third column shows how lender credits reduce closing costs. The middle column represents the scenario where you choose to do neither.

Please note that the information presented in this table is for informational purposes only and may not reflect current market interest rates. It’s important to consult with a licensed mortgage professional to discuss your specific situation and determine the best interest rate and mortgage option for your needs.

Calculating Your Breakeven

The breakeven point refers to the duration needed to recover the initial cost for obtaining the lower interest rate. In this case, the breakeven point is estimated to be 3 years and 9 months. This is calculated by dividing the $1,125 upfront cost by the $24 monthly savings, which equals 46.875 months or roughly 3 years and 9 months.

The Bottom Line

If you’re uncertain about your long-term housing plans or when you might refinance, and you have enough cash for both closing and savings, paying points to lower your interest rate or accepting a higher interest rate for credits may not be the best option. Consult with a loan officer and request two different loan scenarios, one with and one without points or credits, to compare total costs over several possible timeframes, including the shortest, longest, and most likely periods you intend to keep the loan. It may also be beneficial to discuss your options with a HUD-certified housing counselor.

When comparing lender offers, ensure that you request the same amount of points or credits from each lender to make an informed decision.