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Points vs. credits: How they impact your mortgage costs and monthly payment

Do you want to pay more now or later?

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Whether you're shopping for a mortgage or exploring a refinance, you will eventually have to face the question of points or credits. In short, points and credits are levers you can use to tweak your interest rate and closing costs. When you "take" points, you will pay less over the term of your loan but pay more upfront in closing costs. And when you "take" credits, you'll pay less at closing in exchange for a higher interest rate and higher overall loan cost. Bottom line: If you plan to own the home for a long time, taking mortgage points usually results in greater savings over the life of a loan -- even though the costs will be higher initially.

Below, we break down how points and credits impact interest rates, monthly payments and the total cost of a loan.

What are mortgage points?

Mortgage points, also known as discount points, lower your interest rate in exchange for a fee. Mortgage points cost 1% of the mortgage amount and allow you to shave 0.25% off your interest rate. If you're buying or refinancing a home with a $250,000 mortgage with an interest rate of 3.50%, one mortgage point would cost an additional $2,500 in closing costs but lower your interest rate to 3.25%. The lower interest rate benefits you in a lower monthly payment and a lower overall total loan cost. Points can be purchased at closing (the final stage of buying a home, marking the transfer of property ownership to the buyer), a process called "buying down the rate." 

Lenders usually allow you to buy multiple discount points but may limit how much you can buy down your rate. If you do purchase mortgage points, you'll find that information in both your loan estimate and your closing disclosure.

Pros

  • Allows you to save money in interest over the course of your loan
  • Results in a lower monthly payment
  • Can reduce your tax bill, since mortgage points are tax-deductible

Cons

  • Requires a larger upfront cost at a time where you're already spending a lot of money
  • May not be cost-effective if you only own the home for a short time

What are lender credits?

Similar to mortgage points, lender credits allow you to adjust your interest rate and upfront costs. But instead of lowering your interest rate, they give you lower closing costs in exchange for a higher interest rate.

Lender credits are less standardized than mortgage points. As a result, the amount a single credit increases your interest rate and reduces your closing costs will vary from one lender to the next. In some cases, you may be able to use lender credits to completely eliminate your closing costs.

Much like lowering your interest rate with mortgage points also lowers your monthly payment, increasing your interest rate with lender credits also increases your monthly payment. Like mortgage points, you can find information about your lender credits in your loan estimate or closing disclosure.

Pros

  • Reduces your closing costs, which may eliminate a barrier to homeownership
  • Can free money for a larger down payment, home repairs and more
  • Results in a larger annual tax deduction for your mortgage interest

Cons

  • Results in a higher interest rate and potentially more money paid in the long run
  • Causes your monthly payment to be higher, which will reduce money left over in your budget
  • The higher monthly payment could impact your debt-to-income ratio and make it more difficult to get approved for a loan

Choosing between points and credits

Both mortgage points and lender credits allow you to save money, but in different ways. Mortgage points allow you to reduce your interest rate by paying more in closing costs. Generally, if you plan to own the home for a long period of time, then mortgage points will result in greater savings.

Lender credits allow you to save money in the short term in exchange for a higher interest rate. This option frees up cash flow, which can help you put down a larger down payment, pay for home improvements and more. 

Mortgage points are best for borrowers who can afford a larger upfront cost, but who want to save money over the long term. Lender credits, on the other hand, are best for borrowers who prefer a lower upfront cost, and they may result in greater savings if you plan to own the home for a short time. Given the high cost of buying a home, between the down payment and closing costs, lender credits can help lower the entry barrier, making homeownership more affordable and accessible.

In both cases, it's also important to consider your short-term and long-term financial goals and whether the immediate increased liquidity that lender credits provide or the long-term savings that mortgage points provide is more important to help you meet those goals.

If you're wondering which will result in more long-term savings, the key is to find your break-even point. In the case of mortgage points, the break-even point is how long you would have to own the home before the higher upfront cost pays off and you start saving money. In the case of lender credits, the break-even point is the point in time at which your upfront savings have been offset by the higher interest rate.

The break-even point: Mortgage points 

Suppose you're buying a home with a $300,000 mortgage and the lender has quoted you an interest rate of 3.50%. You're wondering whether mortgage points would help you save money.


No Mortgage Points

1 Mortgage Point

2 Mortgage Points

Loan Principal

$300,000

$300,000

$300,000

Interest Rate

3.50%

3.25%

3.00%

Upfront Costs

$0

$3,000

$6,000

Monthly Payment

$1,347

$1,305

$1,264

Break-Even Point

N/A

5.95 years

6.02 years

30-Year Cost Increase

N/A

$14,828.59

$29,491.92

Buying down your rate with both one and two mortgage points would allow you to break even and start saving after around six years. As long as you plan to own the home for at least that long, you're likely to save money. 

The difference between buying down your rate by one mortgage point versus two is that when you buy two mortgage points, your savings over your entire 30-year mortgage are about twice as high.

The break-even point: Lender credits

Let's look at a similar example using the same $300,000 mortgage and 3.50% interest rate, but with lender credits instead of mortgage points.


No Lender Credits

1 Lender Credit

2 Lender Credits

Loan Principal

$300,000

$300,000

$300,000

Interest Rate

3.50%

3.75%

4.00%

Closing Cost

$6,000

$3,000

$0

Monthly Payment

$1,347

$1,389

$1,432

Break-Even Point

N/A

5.95 years

5.88 years

30-Year Savings

N/A

$15,265.04

$30,685.42

In this scenario, lender credits have a similar break-even point as mortgage points. The difference is that in the case of mortgage points, you start saving after about six years. But in the case of lender credits, you stop saving after about six years. 

So, as long as you plan to own your home for less than the break-even period, lender credits might be cost-effective for you.

Calculating points vs. credits online

Using an online calculator can help you determine how mortgage points and lender credits would impact your home buying process and your monthly payment. The information you gain from these calculators could help you decide which is right for you.

For example, Bankrate offers a mortgage payments calculator to help you determine your mortgage payment with and without points so you can compare. This calculator can help you determine how much you'll save during the time you plan to own the home. (Disclosure: Bankrate and CNET are both owned by Red Ventures.) 

Because lender credits aren't as standardized, there are fewer online tools to help you calculate their cost-effectiveness. That being said, your lender can give you an estimate of how much lender credits will increase your interest rate and decrease your closing costs so you can calculate the long-term effects.

Ultimately, deciding whether to use points or credits is a personal decision and will depend on your financial situation. You can discuss your options with your mortgage lender, who can explain how each option would affect your upfront costs and monthly mortgage payment. You can also consult a mortgage broker for a more unbiased opinion.