Mortgage rates have been steadily decreasing throughout August and September, with 30-year fixed mortgage rates hovering at or below 6.5%. In what seems like a miraculous turn, many lenders are offering rates below 6% — which has been an important milestone for Americans waiting to buy a home or refinance their mortgage.
Looking beyond the mortgage rate, however, consumers may be faced with steep up-front costs that offset potential interest savings. Upon closer examination, those sub-6% mortgage rates are weighed down by 2 to 3 mortgage discount points, amounting to thousands of dollars in additional closing costs.
In fact, an April 2024 report from the Consumer Financial Protection Bureau found an increase in the use of discount points in recent years to combat rising mortgage rates.
“Higher interest rates on mortgages have led borrowers to pay up-front fees to lower their interest payments,” says former CFPB Rohit Chopra in the report.
When shopping around for the lowest mortgage rate, consumers may end up applying with a higher-cost lender because the discount points are hidden in the fine print. Here’s what you should consider when comparing the true cost of a mortgage and looking beyond the loan’s interest rate.
[READ: Compare Current Mortgage Rates]
Should You Pay Mortgage Discount Points? It Depends
During the mortgage application process, discount points allow you to pay money at closing to secure a lower interest rate.
Each mortgage discount point costs 1% of the loan amount and may reduce the mortgage interest rate by about a quarter-point, although the exact savings varies. So when a lender advertises a rate that includes multiple discount points, the up-front cost can add up fast.
For example, let’s say a lender is offering a 30-year mortgage at a 5.75% interest rate and a loan amount of $300,000. The offer includes 3 mortgage discount points, which would amount to $9,000 up-front, and the monthly principal and interest payments would be $1,751.
Without paying discount points, the rate might be 6.5% with a monthly payment of $1,896. That’s a difference of $145 monthly. With a rough calculation (not exact, as it doesn’t include mortgage amortization), you can divide the up-front cost by the monthly savings to determine how many months it would take for the discount points to be worthwhile.
In this example, it would take 62 months — more than five years — for the monthly savings to offset the up-front cost of discount points.
A lot could happen between now and then, though. Rates could fall, and you may be able to refinance to a lower rate anyway. But remember that refinancing comes at a cost, too: usually between 2% and 5% of the loan amount. In other words, there are many factors that influence the decision to purchase mortgage discount points.
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When Paying for Mortgage Discount Points Makes Sense
— The mortgage lender or home seller is offering to buy down the rate as an incentive.
— Mortgage rates are rising and you don’t expect them to go lower in the next several years.
— You need a lower rate and payment to qualify for the mortgage.
When You Shouldn’t Pay for Mortgage Discount Points
— You expect mortgage rates to decrease in the next several years (although it’s difficult to forecast mortgage rates).
— You’re prioritizing lower up-front costs, even if it results in a higher rate.
— It would take more than a few years for the monthly savings to offset the up-front costs.
Look at the Mortgage APR for a More Inclusive Cost Estimate
As a first step, you can ask for rate quotes without discount points so you can see which lender really offers the lowest interest rate. Keep in mind that some lenders may charge lower rates but higher origination fees, and vice versa.
To truly compare costs from one lender to the next, look at the annual percentage rate. The mortgage APR includes the interest rate as well as discount points and any other costs like origination fees.
You won’t be able to lock in the finalized rate until you formally apply for a mortgage tied to a specific property address. That’s because mortgage rates depend on a number of factors, including the property’s location down to the ZIP code.
However, it’s still possible to shop around for rates with no obligation before you begin applying with lenders. Just know that the prequalified rate quote you see may be different from the final offer you receive.
Finally, mortgage rates can fluctuate from one day to the next — and even multiple times throughout the day. If you’re happy with the offer you’ve received, you’ll need to lock in your mortgage rate to avoid increases during the closing process.
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Mortgage Rate Too Good to Be True? Read the Fine Print originally appeared on usnews.com
