Buying Down Your Mortgage Interest Rate

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Considering buying down your mortgage interest rate is important when getting a new home loan.  Due to the added initial costs to buy down your interest rate, you should do your due diligence and make sure it is the right move for you.

Buying Down Your Interest Rate

What exactly is buying your interest rate down?   Buying down your interest rate means paying additional up front costs costs to obtain a lower than market interest rate on your home loan.  Often, lenders refer to these costs as “points”.

Buying down your interest rate is a “thing” because you are literally pre-paying mortgage interest.  After-all, mortgage lenders need a specific amount of interest revenue on each loan to create profit.  Whether interest is paid monthly or up front it is all interest from the lender’s perspective.   Due to this idea, mortgage lenders allow borrowers to pay a portion of interest up front as “points”.

The up front fees or points serve as a partial pre-payment of interest to your mortgage lender.  As such, when someone buys their interest rate down lenders do not need to charge the normal rate.  As a result, borrowers paying points to buy their rate down receive a lower interest rate than they would have without paying points.

When Paying Points Saves You Money

The determination of what benefit you receive from paying points to buy your mortgage interest rate down resides primarily within the break even point.   In other words, the break even point is when your accumulated monthly payment savings exceed the cost point (“points”) you paid.  Monthly payment savings equal the difference between your mortgage payment at the rate your would have received without buying it down and the mortgage payment at the bought down rate.

While fortune telling is tricky, paying points to buy down your interest rate requires some best guessing.  Seeing through the crystal ball and finding out how long you plan to keep the financed home is central.

With your best guess in hand, multiply the number of months you plan to keep the home by the monthly savings from the bought down interest rate.   This number should exceed what it cost you to buy your rate down.  Otherwise, you are likely wasting money buying down your rate.

Cost of Buying Down Your Interest Rate

While no set in stone schedule exists, the cost of buying down your rate follows a pattern.  In short, the more you buy your rate down the more it will cost you.  The cost or points are measured in terms of percentage of the loan amount you borrow.   For example, if the cost to buy your rate down is quoted by your lender as a cost of 1% that translates to a cost equal to your loan amount x 1%.   For example:

  • $400,000 x 1% = $4,000 cost

In conclusion, buying down your rate is a case by case situation relative to viability.  For some it will not make sense.  However, in certain scenarios buying down your interest rate is a great tool.  Typically speaking, the longer you plan to keep the financed home the more beneficial buying your rate down will be.

By Jeremy House

 

 

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