How Many Points For a 1/4% Break in Mortgage Rate?
June 21, 1999, Revised August 28, 2007
"My lender offered to reduce the interest rate on my 30-year fixed-rate mortgage from 6.75% to 6.50% for another 1.50 points. Is this a fair price?"
No, the price is high, but it is difficult to know exactly how high without more information.
Lenders today offer borrowers a range of interest rate/ point combinations, leaving it to borrowers to select the combinations best suited to their needs. Points are charges that must be paid to the lender upfront, expressed as a percent of the loan amount, where 1 point equals 1%.
High rate/low point combinations are good for borrowers who are either cash short or who don't expect to be in their house very long. Low rate/high point loans are for borrowers who can meet the cash requirement, and either have a long time horizon or need to reduce their monthly mortgage payment.
Borrowers should decide on their shopping rate early in the shopping period, rather than wait until they are committed to a particular lender. One reason is that the lender offering the lowest points at one rate is not necessarily the same as the lender offering the lowest points at a different rate.
For example, on April 27, 1999 I shopped 15 national lenders for a $200,000 30-year fixed-rate mortgage in California with a 30-day lock. For each of 5 interest rates ranging from 6.25% to 7.25%, I identified the lender charging the fewest points. One lender charged the fewest point at 2 rates, but 3 different lenders charged the fewest points at the remaining 3 rates.
But there is another reason not to get locked into one lender before making the final rate/point decision, which is illustrated by your letter. The 1.50 points you paid to reduce the rate from 6.75% to 6.5% compared to 1.125 points being charged by most of the national lenders I surveyed on the day I received your letter, and none charged more than 1.25 points. What happened to you is that you were too far along in the process to back out, and the loan officer took advantage of an opportunity to make a few extra dollars by padding the price.
Even though you were committed to this lender, you probably would have avoided the overcharge if you had information on all the rate/point combinations offered by that lender at the outset. They won't change the price on you if you have already seen it. This is why some loan officers are reluctant to provide complete rate/point information to their customers.
Note: setting a shopping rate is only one part of a viable shopping strategy. For a more comprehensive analysis, read How to Shop For a Mortgage.
Readers should not conclude from what I said above that a 1/4% reduction in rate should be priced at about 1.125 points. This was the price charged by most lenders to reduce the rate from 6.75% to 6.50%, but the price most of them charged to reduce the rate from 7.50% to 7.25% was only .75 points.
Why the difference? The lender's loss in reducing the interest rate by 1/4% depends on how long the loan remains in force. Higher rate loans are refinanced more quickly, and therefore have a shorter life, than lower rate loans. Since the loss from the rate reduction is smaller, the price of the reduction is lower. For similar reasons, the prices for 15-year loans are usually a little lower than they are for 30-year loans.
The table below shows typical prices of 1/4% rate reductions on April 26, 1999 and August 28, 2007. One 15-year observation on the recent date was out of line, but that happens sometimes.
"My lender offered to reduce the interest rate on my 30-year fixed-rate mortgage from 6.75% to 6.50% for another 1.50 points. Is this a fair price?"
No, the price is high, but it is difficult to know exactly how high without more information.
Borrowers Can Select Their Rate/Point Combination
Lenders today offer borrowers a range of interest rate/ point combinations, leaving it to borrowers to select the combinations best suited to their needs. Points are charges that must be paid to the lender upfront, expressed as a percent of the loan amount, where 1 point equals 1%.
High rate/low point combinations are good for borrowers who are either cash short or who don't expect to be in their house very long. Low rate/high point loans are for borrowers who can meet the cash requirement, and either have a long time horizon or need to reduce their monthly mortgage payment.
Borrowers Should Select a Shopping Rate Before Selecting a Loan Provider
Borrowers should decide on their shopping rate early in the shopping period, rather than wait until they are committed to a particular lender. One reason is that the lender offering the lowest points at one rate is not necessarily the same as the lender offering the lowest points at a different rate.
For example, on April 27, 1999 I shopped 15 national lenders for a $200,000 30-year fixed-rate mortgage in California with a 30-day lock. For each of 5 interest rates ranging from 6.25% to 7.25%, I identified the lender charging the fewest points. One lender charged the fewest point at 2 rates, but 3 different lenders charged the fewest points at the remaining 3 rates.
But there is another reason not to get locked into one lender before making the final rate/point decision, which is illustrated by your letter. The 1.50 points you paid to reduce the rate from 6.75% to 6.5% compared to 1.125 points being charged by most of the national lenders I surveyed on the day I received your letter, and none charged more than 1.25 points. What happened to you is that you were too far along in the process to back out, and the loan officer took advantage of an opportunity to make a few extra dollars by padding the price.
Even though you were committed to this lender, you probably would have avoided the overcharge if you had information on all the rate/point combinations offered by that lender at the outset. They won't change the price on you if you have already seen it. This is why some loan officers are reluctant to provide complete rate/point information to their customers.
Note: setting a shopping rate is only one part of a viable shopping strategy. For a more comprehensive analysis, read How to Shop For a Mortgage.
The Price of a Rate Reduction Varies With the Rate
Readers should not conclude from what I said above that a 1/4% reduction in rate should be priced at about 1.125 points. This was the price charged by most lenders to reduce the rate from 6.75% to 6.50%, but the price most of them charged to reduce the rate from 7.50% to 7.25% was only .75 points.
Why the difference? The lender's loss in reducing the interest rate by 1/4% depends on how long the loan remains in force. Higher rate loans are refinanced more quickly, and therefore have a shorter life, than lower rate loans. Since the loss from the rate reduction is smaller, the price of the reduction is lower. For similar reasons, the prices for 15-year loans are usually a little lower than they are for 30-year loans.
The table below shows typical prices of 1/4% rate reductions on April 26, 1999 and August 28, 2007. One 15-year observation on the recent date was out of line, but that happens sometimes.
| Price For a 1/4% Reduction in Rate | |||
| April 26, 1999 | August 28, 2007 | ||
| 30-Year Fixed-Rate | |||
| 6.25% to 6.00% | 1.375 Points | 5.75% to 5.50% | 1.22 Points |
| 6.75% to 6.50% | 1.125 Points | 6.25% to 6.00% | .969 Points |
| 7.50% to 7.25% | 0.75 Points | 6.75% to 6.50% | .779 Points |
| 15-Year Fixed-Rate | |||
| 6.00% to 5.75% | 1.125 Points | 5.25% to 5.00% | .86 Points |
| 6.50% to 6.25% | 0.875 Points | 6.00% to 5.75% | .932 Points |
| 7.25% to 7.00% | 0.75 Points | .50% to 6.25% | .789 Points |