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MORTGAGE
Should I buy down my mortgage rate?
What you'll learn: What buy down points are and how to decide if you should buy down your rate
EXPECTED READ TIME: 5 MINUTES
August 18, 2023
Should I Buy Down My Mortgage Rate?
Whether mortgage rates are at all-time lows or rising, you might wonder if you should buy down your mortgage interest rate. Buying down your rate means you’ll pay a one-time up-front fee for a lower interest. Today, we’ll discuss how to know if it’s a smart choice or not. Read on to find out more, so you can feel confident in your decision.
How do mortgage rates work?
Before we dive into buying down your interest rate on a mortgage, let’s discuss the basics of how lenders see and quote interest rates.
First, most interest rates change daily – sometimes more than once. While others, like VA loan rates, are more consistent and might not change as often. Lenders offer interest rates based on many factors including the economy and your financial picture. As a borrower, you’ll have a choice on whether you want a credit, take the par rate, or pay down your rate:
- Credit – A higher rate will provide a credit for you to use toward closing costs.
- No credit or cost – An interest rate at par is a baseline rate. There’s no cost or credit. This is the rate many lenders quote when asked what their current rate is.
- Cost – A lower than par rate will cost you a one-time fee.
The above rate structure applies to credit unions, banks, and mortgage bankers that lend out their own funds, or mortgage brokers that broker out their loans to a third party.
For example, if you’re short on closing costs, you could get a higher rate and receive a credit to help pay for those costs. If you’re happy with the par rate, you don’t have to do anything. And if you want the lowest rate possible, you can do a point buy down.
What does it mean to buy down points?
What are buy down points? Mortgage points, also called discount points or buy down points, all mean the same thing: a fee your lender collects in exchange for a lower interest rate.
One discount point equals one percent of the loan amount. If you have a $500,000 loan, one point would cost $5,000.
Generally, one point can buy a rate down by an eighth to a quarter percent. The reduction is based on your lender, the type of loan, your financial picture, and what’s happening in the mortgage market as a whole.
Note: Discount points are different from “origination” or “lender” points. These are points the lender charges for doing your loan. Many lenders, including PenFed, do not charge origination points.
How do mortgage points work?
Though points will increase your initial costs, they can reduce your monthly mortgage payments and save money on the loan in the long run. Here’s a sample comparison with a $500,000 home loan with a 30-year term:
|
|
No Points |
1 Point |
2 Points |
|---|---|---|---|
|
Interest Rate |
7.00% |
6.75% |
6.50% |
|
Fee |
$0 |
$5,000 |
$10,000 |
|
Monthly Payment (Principal & Interest) |
$3,327 |
$3,243 |
$3,160 |
|
Total Interest Paid |
$697,544 |
$667,477 |
$637,722 |
As you can see, more buy down points lead to a lower interest rate, lower monthly payment, and less total interest paid on the loan. But how do you know if the up-front cost of buying down your rate with points is worth it?
Is it wise to buy down your mortgage rate?
To determine if a buy down is worth it, calculate how long it will take to break even on the investment. This is called the breakeven point.
To calculate the breakeven point:
- Determine the monthly savings between your potential payments.
- Divide the up-front cost to buy the rate by the monthly savings.
- Divide by 12 to see the years until you break even.
Using our example above comparing no points to one point:
- $3,327 – $3,243 = $84 monthly savings
- $5,000 ÷ $84 = $59.52
- $59.52 ÷ 12 = 4.96 (round to 5)
So, it would take five years to make up the initial $5,000 cost. If you know you’ll live in the home for longer, it could be a worthwhile investment. If there’s a chance you’ll move beforehand, it may not be worth it.
Should I buy down my mortgage rate?
Having the lowest interest rate possible may sound appealing. But spending your hard-earned money on discount points isn’t always the best decision – especially if you may move before or shortly after the breakeven point.
It can help to take away the emotion of finding the lowest rate. Instead, look at the bigger picture. Here are some questions to ask:
- How long will it take to recoup the up-front cost?
- How long do I plan to own this house?
- Would it make sense to refinance down the road instead?
When comparing lenders, compare rates, fees, and the cost to buy your loan down. Once you have that data, select your lender based on excellent rates and service. And remember, the mortgage market is fluid. If you’re ready to move forward in your loan, lock your loan, and are satisfied with the rate and buydown, consider locking that day.
