What You Need to Know About Buying Down Mortgage Rates

For the most part, the world of mortgages isn’t really that complicated. You and the lender agree on an interest rate, term (usually 15 or 30 years, with most people taking the latter), payment amount, and so on.

Where things get more complicated is when lenders talk about buying down mortgage rates. What exactly does that mean? Just how much money can you save? Let’s take a closer look.

The process

Unfortunately for borrowers, lenders aren’t giving you lower interest rates out of the goodness of their hearts. That would mean lower profits for them and their shareholders. So you have to pay up front for a better rate.

These fees are called points, and they tend to come in 1% increments. Using an example of a $200,000 mortgage, a borrower might buy 2,000 points in exchange for a lower rate. These points are then added on the top of the mortgage. A $200,000 mortgage now becomes a $201,000 mortgage.

But in exchange for adding these points on the top of their mortgage, a borrower gets a better rate. 2,000 points at the beginning might qualify someone for a reduced rate of 3.25% when the going rate is 3.4%, as an example.

Because the interest rate is lower throughout the life of the mortgage, a person who owns their own home for the long-term ends up doing pretty well when they buy down their mortgage rate. Paying $2,000 more at the beginning might add up to $8,000 or even $10,000 worth of interest savings over a 30-year loan. That’s a good deal.

On the other hand, the lender wins if somebody buys a property and then moves out within a few years.

Who pays for points?

For the most part, it’s the borrower who pays for points. They have to come up with the cash to pay for the points out of their own pocket, plus have enough for a down payment.

In certain situations, however, a seller may pay for points. A common incentive for builders is to offer points to buyers, and while most buyers negotiate with sellers to pay some (or all) of their closing costs, it’s not unheard of for buyers to ask sellers for extra cash at closing for points.

Should you buy down your mortgage rate?

There are a number of variables that go into buying down a mortgage rate, but it typically comes down to just a couple of factors: how long you plan to stay in the home, and the difference in rates.

As previously mentioned, the longer you stay in your home, the more it’ll make sense to use points to buy down your mortgage rate. But how do you tell exactly when such a move will pay off?

You’ll have to figure out the break-even cost, which isn’t very hard. All you do is take the amount paid for the points (say $2,000) and the difference in monthly payment (say $25 per month). That gives us a break-even of 80 months, or just over 7.5 years.

Over an entire 30-year loan, this works out to spending $2,000 today to save a grand total of $9,000. That’s a good deal; it’s the equivalent of earning a little over 5% guaranteed over 30 years. That sure beats the average rate on a savings account or a CD.

Your mortgage broker or banker can also help you determine your break-even cost.

The Final Word

Buying down your mortgage rate is usually a pretty good deal, assuming you stay in the house for a while. If you have the spare cash come closing time, it’s definitely something you should consider.