When interest rates are high, some borrowers may choose to buy down their interest rate to lower monthly payments and make their mortgage more affordable.
Buying down the interest rate means paying an extra upfront fee to get a lower rate and monthly payment. This is referred to as buying “mortgage points” or “discount points.”
When interest rates are low, on the other hand, few borrowers pay higher closing costs to get a discount.
But as mortgage rates rise, borrowers are more likely to weigh the pros and cons of buying points to reduce their rate. I’m linking to an article by Michele Lerner at The Mortgage Reports that explains this in depth…and I invite you to check it out.
Here are a few highlights and thoughts from her article…
Pros of Buying Down the Interest Rate
The biggest reason to buy down your interest rate is to get a lower rate on your mortgage loan, regardless of credit score.
Lower rates can save you money on both your monthly payments and total interest payments over the life of the loan.
In addition:
- If your income is too low for you to qualify for the house you want, you may be able to afford the purchase price with a reduced interest rate and payment
- If you can convince a home seller to pay discount points for you, buying down your interest rate may help you qualify for your mortgage loan
- Since discount points represent prepaid mortgage interest, the cost is often tax-deductible (provided that you itemize your deductions). Ask a tax professional for more information
Cons of Buying Down the Interest Rate
The primary drawback when you buy down your mortgage interest rate is that it increases the upfront cost of buying a home.
Your monthly payments will be lower, but you need to “break even” for those saving to be worth it. That means you should plan to keep the home loan long enough that your total savings outweigh the upfront cost of buying points.
Buying mortgage points also ties up your liquid cash. You may have better uses for that money; for example, paying off high-interest credit card debt, making investments, or saving for future home improvements.
You may also want to use the cash to invest in assets other than real estate for diversification, to boost a college tuition fund, or to pad your retirement account.
Finally, if you’re making a down payment of less than 20% — or have less than 20% in home equity when refinancing — you’ll probably have to pay for private mortgage insurance (PMI) on a conventional loan. Thus, it could be best to use your cash for a larger down payment rather than buying points.
How Does a Mortgage Buydown Work?
Buying down your mortgage interest rate involves purchasing discount points (also known as “mortgage points”).
You’ll pay an upfront fee to the lender at closing in exchange for a lower rate over the life of the loan.
Most types of mortgage loans allow buyers to purchase discount points, including conventional, FHA, VA, and USDA loans.
The rate reduction per point depends on the mortgage lender and the type of loan. However, as a rule of thumb, a mortgage point costs 1% of your loan amount and lowers your rate by about 0.25%.
Let’s look at an example, using a $400,000 mortgage amount:
- Original quote: $400,000 mortgage at 6.25%
- One discount point costs $4,000
- One point lowers the rate by 0.25% (from 6.25% to 6.00%)
- Over 30 years at 6.25%, you’d pay $486,600 in total interest
- Over 30 years at 6%, you’d pay only $463,300 in total interest
- Extra upfront cost of buying points: $4,000
- Savings from buying points: $23,300
The actual savings and interest rate reduction will vary depending on your loan and lender. Ask your loan officer to show you a few different quotes, with and without points, so you can understand how the potential cost and savings stack up.
Types of Mortgage Rate Buydowns
Mortgage rate buydowns come in a wide variety of options.
Here’s a summary of what you might find when you start shopping around for a mortgage rate reduction:
- Permanent buydown: This buydown results in the interest rate being lowered by a certain percentage for the entire duration of the mortgage.
- Temporary buydown: This buydowns typically results in a temporary reduction in the interest rate for a specified period, often the first few years of the mortgage term.
- 3-2-1 buydown: This option involves a more gradual reduction in the interest rate over the initial three years of the loan, with each year representing a different interest rate tier (e.g., 3% lower in the first year, 2% in the second, and 1% in the third).
- Seller contributions: In some cases, sellers may offer to contribute to the buyer’s closing costs, which can be used to fund a buydown.
In Conclusion
Mortgage rates have recently fallen from their 2023 peaks. However, they’re still much higher than a few years back so paying discount points can help you save.
To see what you qualify for, give me a call and we can go through multiple scenarios. I can show you rate quotes both with and without mortgage points so you know how much you could save on your rate — and what it would cost you!
If you’d like to find out more and discuss the pros and cons of discount points, don’t hesitate to reach out to me!
The blog postings on this site represent the positions, strategies or opinions of the author and do not necessarily represent the positions, strategies or opinions of Guild Mortgage Company or its affiliates. Each loan is subject to underwriter final approval. All information, loan programs, interest rates, terms and conditions are subject to change without notice. Always consult an accountant or tax advisor for full eligibility requirements on tax deductions.
