Should You Pay Points In Exchange for Lower Interest Rates?

Interest rates, points, refinancing – if you’re confused by the terms, don’t worry. This article explains what you need to know about points and how they relate to interest rates and the overall cost of a loan.

A point is a fee imposed by a lender. Every point being charged is equal to one percent of the total amount you are borrowing. So one point on a $150,000 loan equals $1,500, two points on that same loan equals $3,000, three points equals $4,500 and so on.

Most refinancing specialists charge points for the different interest rates that they offer. As a general rule, for every point a lender charges, you can expect the increase in the interest rate to be between one eighth to one quarter of a percent.

A lender usually charges more points when quoting lower interest rates. If a lender tells you that no points are being added, you can be pretty sure you’re getting a higher interest rate than you may be entitled to.

Deciding which is the right combination comes down to figuring out the upfront costs versus the monthly costs. Typically the shorter the amount of time you keep the loan, the more expensive the points are and vice versa. In other words, paying more points in exchange for a lower interest rate usually makes sense if you are not planning to move anytime soon.

As an alternative to paying the cost of the points up front, many lenders will let you finance the cost by adding the cost of the points to your loan balance. This makes sense in some situations, like when doing so makes it possible to obtain financing. But understand that when set up this way, you will pay interest on those added costs and that will increase your monthly mortgage payment accordingly.