Understanding Interest Rates and Mortgage Points

• August 16th

by UrbanTurf Staff

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As UrbanTurf regularly points out, the long-term interest rates announced by Freddie Mac each week are not quite as good as advertised, as they usually carry points with them. And as interest rates reach highs not seen in decades, it is critically important that borrowers understand how points work. 

Points are essentially a form of pre-paid interest on a loan. When Freddie Mac issues its mortgage rates, the published average usually includes an average "point" that the lender will charge. That point translates into a percentage of the total loan that the borrower must pay up front in order to get the latest interest rate. For example, if a borrower is looking to get a $600,000 home loan and mortgage rates are at 6.5 percent, with 0.8 of a point as the average, that means that they will have to pay 0.8 percent of the total loan amount ($4,800) up front to get the quoted rate. (Of course, a variety of other factors — credit score, down payment amount — also play into getting the lowest rate available.)

Conventional wisdom suggests it takes somewhere in the 5- to 7-year range to recoup the point that you would pay upfront on a loan, which is good for buyers to keep in mind as they consider how long they will live in the property they are purchasing. For example, say that you want to take out a $500,000 home loan and you have the option of a 30-year fixed-rate mortgage at 5.5 percent with no points or 5 percent with 0.8 of a point. Monthly payments on the first option would be $2,838. After an upfront payment of $4,000, payments on the second loan would be $2,623. The time it would take to make up the difference between the two loans is about 5.5 years.

In today's mortgage market, however, it is not out of the question to find a good rate on a conventional loan that does not carry any points. A borrower just usually needs to have a very good credit history and be able to put 20 percent down.

For more on mortgage points, particularly as they relate to taxes, click here.

This article originally published at https://dc.urbanturf.com/articles/blog/first-timer_primer_interest_rates_and_mortgage_points/6745.