Rate Buy Down
Lenders will often offer a new home buyer the option of paying for discount points upfront to reduce the interest rate on their mortgage. One discount point is equivalent to one percent of the loan. This fee is either due or closing or could be rolled into the principal of the loan. Lenders allow borrowers to purchase between one and four points on a loan. Each point reduces the overall interest rate on the loan by 0.25%. Purchasing points in order to secure a lower interest rate is referred to as a “rate buy down.”
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Will a Rate Buy Down Save you Money?
Although many mortgage brokers will advertise loans that are “free” or have “zero points” added, these loans are not always the best option. It might be tempting to go with a loan that has no addition fee upfront, but sometimes buying down a rate, or paying points for a lower interest rate is a financially smart decision.
The question to ask is – will purchasing points and buying down the interest rate save you money? The quick answer is – the longer you hold onto your property and pay down the loan, the more money you will save by buying down the rate. But if you plan to sell the property or refinance your loan in the next five years, adding points might not be beneficial. It comes down to math. Let’s say that you are looking at a 30-year, $500,000 loan with a 6% interest rate and no points added. Your monthly interest payment would be $83.33. If you buy down the rate by one point, your loan is now $505,000 with an interest rate of 5%. In this case, your monthly interest rate is $70.14. That’s a difference of $13.19 a month. It would take you about 32 months to break even on the $5,000 you paid to lower the rate. So, if you plan to keep the loan for more than 32 months, you will end up saving money.
Pros and Cons of Buying Down a Rate
If the math works out, and you decide to keep your property as a long-term investment, buying down a rate can save you $10,000 or more over the life of a loan. A small upfront investment can truly pay off over 20 or 30 years with a lower interest rate.
The downside of paying down a rate is that you have invested in your specific mortgage loan. If you decide to refinance or sell your house before you have reached a breakeven point on your rate buy down, you will end up losing money. Before you decide one way or the other, it’s important to have a good idea of how long you will want to stay in your home and maintain the loan. If you plan to refinance within the first three to five years, a rate buy down might not make sense.
