Rates
and Points
The interest rate determines the monthly interest
payments over the lifetime of the loan. A "point"
or "discount point" is equivalent
to 1% of the loan amount and usually reduces
or "discounts" the loan rate by an
eighth of a percentage point.
For example: You want to get a loan for $100,000
to buy a home. Each "point" would
cost you 1% of $100,000 or $1,000 but would
reduce your loan's interest rate by .125%. The
lender might offer you an 8.0% loan with zero
points, a 7.875% loan with one point, or a 7.75%
loan with 2 points.
Points, like the down payment, are paid at
closing. In some cases, lenders will allow borrowers
to finance the points over the term of the loan.
Lenders sometimes use points to make their interest
rates appear lower. Be aware that lower interest
rate offered by a lender may translate into
higher points requirements.
Should You Pay More or Less "Up-Front"?
The size of the down payment, money paid at
closing, can affect your mortgage in a number
of ways.
Higher up-front payments result in:
- lower monthly payments
- lower private mortgage insurance (PMI)
costs (if applicable)
- lower interest payments
- In fact, making a down payment of 20% or
more can save the homebuyer money by avoiding
the monthly mortgage insurance payments.
On the other hand, lower up-front costs mean
that your cash requirements at closing are much
less, although monthly payments may be somewhat
higher.
These lower up-front costs may be a significant
benefit for first-time homebuyers and people
who simply don't have a lot of cash on hand.
The Department of Housing and Urban Development
(HUD) has some tips that may be helpful to you
as you shop for mortgages.
Buydown vs. GPM
While these two mortgage types start the homebuyer
off at one rate and increase the rate over time,
one of these types of mortgages may be right
for you:
Buydown
Type of mortgage loan where the loan rate is
reduced by paying more up-front at closing and
is increased by one percent each year for the
period set for the loan product. For example:
For a 2-1 buydown at an 8% rate, Year 1 the
rate is 6%, Year 2 the rate is 7%. For Year
3 through the life of the loan, the rate is
8%.
Qualification rules for the loan programs remain
the same. Depending on the lender, the buyer
may qualify using the reduced rate. (Example:
For a 3-2-1 Buydown at a rate of 8%, the buyer
could qualify using the 5% rate.)
The difference between the actual payment schedule
and the rate schedule is usually paid "up-front"
at closing. This can be paid by the seller,
the buyer, the homebuilder, or in some cases,
the lender. If the cost is borne by the lender,
it is usually offset with increased rates or
in points. Generally the funds used to buy down
the loan are held in a separate account and
are applied with the borrower's payment to equal
the true interest rate.
Graduated Payment Mortgage (GPM)
Type of mortgage loan where the mortgage payments
increase gradually for a period established
in the loan product, typically five years. This
is a negatively amortizing loan, which means
that the difference between the interest paid
and the interest due is deferred and added to
the loan balances. Because of this, your loan
amount will increase once you start paying off
the loan; it will amortize normally at the end
of the loan period. These loan products are
more popular when the interest rates are higher,
providing a financial incentive for potential
buyers.
Since many lenders will qualify a buyer at
a lower rate, a buyer can secure a larger mortgage.
These loan types are good for those buyers who
expect their incomes to increase to cover the
increase in loan amount.
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