Buying Down Your Mortgage Rate: How it Works and When It Makes Sense

When shopping for a mortgage, most people focus on finding the lowest interest rate possible. While interest rate and monthly payment are important, it is also equally important to consider closing costs, specifically, discount points.

How Buying Down a Mortgage Rate Works

Buying down your mortgage rate means paying an upfront fee at closing, called discount points, to lower your loan’s interest rate. One point typically equals 1% of the loan amount, and usually reduces the rate by about 0.25% to 0.50%.

For example, on a $300,000 mortgage, one point would cost $3,000. If paying that point reduces your interest rate from 6.50% to 6.00%, your monthly payment would decrease, and the savings would add up over the life of the loan.

The key factor to consider is the break-even point. This is the amount of time it takes for your monthly savings because of the lower payment to eclipse the upfront cost of the points. If you plan to stay in your home beyond that period, buying down your rate could be a smart financial move.

Advantages of Buying Down Your Rate

The obvious benefit of buying down your rate is a lower monthly payment. This lower payment can help free up monthly cash flow, so you can focus on savings and other expenses. Buying down your rate can also make a significant impact on total interest paid over the life of your loan. Even a quarter-point reduction in rate can add up to thousands of dollars in savings. Additionally, most lenders offer the option to include the discount points fees into the loan itself, meaning you don’t have to pay anything out of pocket to lower your rate.

Disadvantages to Consider

While buying down your rate can be beneficial, there are trade-offs to keep in mind. The upfront cost can be significant,  may not be feasible for every borrower.

The savings also take time to materialize. If you sell the home or refinance before reaching your break-even point, you may not recoup the money you spent on points.

Another drawback is liquidity. Money used to buy points is money that could be used elsewhere such as for a down payment, home improvements, or emergency savings. For some buyers, keeping cash on hand may be the better move.

Temporary vs Permanent Buydowns

It’s worth noting that there are both temporary rate buydowns and permanent rate buydowns. A permanent buydown lowers your interest rate for the life of the loan, which is what most people think of when paying points. A temporary buydown lowers your rate for the first few years of the loan, such as a 2-1 buydown, where the rate is reduced by 2% for the first year and 1% for the second year, before returning to the full rate in year three.

Temporary buydowns can make sense for buyers who expect their income to increase in the near future or who need lower initial payments to ease into homeownership. Permanent buydowns are better for long-term savings.

Who Benefits the Most from a Rate Buydown?

Buying down the rate is most beneficial for borrowers who plan to stay in their home for the long term. If you expect to keep the mortgage for many years, the savings can more than often offset the upfront cost.

Buying down your interest rate is also great for those looking into a debt consolidation loan. The primary goal of consolidating debt is to save money on interest and reduce your monthly expenses. Lowering the rate on your mortgage can help contribute to these goals in a big way.

Tips for Deciding if a Rate Buydown Is Right for You

To decide whether a buydown makes sense, consider the following:

• Calculate your break even point by dividing the cost of the points by your monthly savings.
• Think about how long you’ll keep the home. If it’s longer than the break-even point, a buydown may pay off.
• Consider your cash flow. If you need liquidity for other expenses, paying points may not be the best choice.
• Look at market conditions. If rates are expected to fall, buying down the rate now may not make sense.

Final Thoughts

Buying down your mortgage rate can be a smart financial move, but it depends on your unique situation. The decision comes down to how long you plan to keep the home, how much upfront cash you can comfortably put toward points, and whether the long-term savings outweigh the immediate cost.

At Fourth City Mortgage, we help clients run the numbers to see if buying down the rate makes sense for them. Every borrower’s situation is different, and our team can guide you through the options to make sure you’re getting the most out of your mortgage.