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You may have missed it during the holiday activity, but the Federal Reserve made a big announcement at the end of 2021: Mortgage rates are going up in 2022.
With the era of historically low interest rates coming to an end, how else can borrowers save money on their mortgage payments? It may be time to consider two other options at your disposal: mortgage points and lender credits.
Both points and credits are tools that a mortgage lender offers to either lower your interest rate or your closing costs. Here’s a guide to how each of them work, and when it might be the right solution for you.
Mortgage Points Explained
Mortgage points are an extra fee that you pay upfront when you purchase a home in exchange for a lower interest rate over the life of your mortgage. This exchange is often called “buying down” your interest rate, which admittedly sounds a little confusing.
Typically, each “point” costs 1% of your loan amount, and decreases the interest rate by 0.25%, says Melissa Cohn, an executive mortgage banker at William Raveis Mortgage. For example, if your mortgage is $200,000 with a 3.25% interest rate, you could pay an extra “point” at closing — in this case, $2,000 — and decrease your interest rate to 3%.
“This is a strategy to think about if you’re thinking of living in the home for a longer period of time,” says Katie Bossler, a quality assurance specialist at GreenPath Financial Wellness, a nonprofit financial counseling organization. The higher upfront cost pays off in the form of less interest paid over the life of the mortgage (typically 30 years), and you’d need to stay in the home long-term to realize those benefits.
Ahead, let’s look at the pros and cons of buying down your mortgage interest rate with points.
Advantages of Mortgage Points
The primary benefit of mortgage points, according to both Cohn and Bossler, is the lower interest rate. That comes in the form of lower monthly mortgage payments, but also has a big impact on the total amount of interest you pay over the life of the loan.
It can also help with your taxes: “A [mortgage] point is tax deductible, so it gives you a little bit of an extra tax deduction,” says Cohn.
Drawbacks of Mortgage Points
The main drawback of mortgage points is the higher closing cost …….