Is it worth buying down your rate?
When mortgage rates rise, borrowers scramble to find the lowest rate and beat the market.
One option is to buy down your interest rate. Buying down the rate means paying an extra upfront fee to get a lower interest rate and monthly payment. This is referred to as buying “mortgage points" or “discount points.”
When interest rates are low, few borrowers pay higher closing costs to get a discount. But as mortgage rates rise, borrowers are more likely to weigh the pros and cons of buying points. Here’s what you should know.
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Pros and cons of buying down the interest rate on a mortgage
|Lower mortgage interest rate||Increased closing costs|
|Lower monthly mortgage payment||Potential to lose money if you refinance or sell before breaking even|
|Potential to qualify for a larger loan amount||Depletes your savings|
|Save money over the life of the loan||Potentially less money to spend on a down payment|
Benefits of buying down your interest rate
The biggest advantage of buying down interest rates is that you get a lower rate on your mortgage loan, regardless of your credit score. Lower rates can save you money on both your monthly payments and total interest payments over the life of the loan.
- If your income is too low for you to qualify for the house you want, you may be able to afford the purchase price with a reduced interest rate and payment
- If you can convince a home seller to pay discount points for you, buying down your rate may help you qualify for your mortgage loan
- Since discount points represent prepaid mortgage interest, the cost is often tax-deductible (provided that you itemize your deductions). Ask a tax professional for more information
First-time home buyers who anticipate staying in their homes for a long time may find buying down their interest rates to be a good decision. That’s because the early years of homeownership can be more expensive, and first-time home buyers’ incomes may be lower. A better rate can drop your monthly payments and even help you qualify for a more expensive home.
Drawbacks of buying down your interest rate
The primary drawback to buying down your mortgage rate is that it increases the upfront cost of buying a home.
Your monthly payments will be lower, but you need to “break even” for those saving to be worth it. That means you should plan to keep the home loan long enough that your total savings outweigh the upfront cost of buying points.
Buying points also ties up your liquid cash. You may have better uses for that money; for example, paying off high-interest credit card debt, making investments, or saving for future home improvements. You may also want to use the cash to invest in assets other than real estate for diversification, to boost a college tuition fund, or to pad your retirement account.
Finally, if you’re making a down payment of less than 20% — or have less than 20% in home equity when refinancing — you’ll probably have to pay for private mortgage insurance (PMI) on a conventional loan. Thus, it could be best to use your cash for a larger down payment rather than buying points.
How buying down interest rates works
Buying down your mortgage interest rate involves purchasing discount points (also known as “mortgage points”). You’ll pay an upfront fee to the lender at closing in exchange for a lower rate over the life of the loan. Most types of mortgage loans allow buyers to purchase discount points, including conventional, FHA, VA, and USDA loans.
The rate reduction per point depends on the lender and the type of loan. However, as a rule of thumb, a mortgage point costs 1% of your loan amount and lowers your rate by about 0.25%.
Let’s look at an example, using a $400,000 mortgage amount:
- Original quote: $400,000 mortgage at 6.25%
- One discount point costs $4,000
- One point lowers the rate by 0.25% (from 6.25% to 6.00%)
- Over 30 years at 6.25%, you’d pay $486,600 in total interest
- Over 30 years at 6%, you’d pay only $463,300 in total interest
- Extra upfront cost of buying points: $4,000
- Savings from buying points: $23,300
The actual savings and interest rate reduction will vary depending on your loan and lender. Ask your loan officer to show you a few different quotes, with and without points, so you can understand how the potential cost and savings stack up.
How much money can you save buying mortgage points?
Whether or not you save money by buying down your interest rate depends on your break-even point. This is the number of years, months, or mortgage payments it will take before buying mortgage points is worth it.
For example, if you pay several thousand dollars to buy down your rate, but you sell or refinance your home before your specific break-even point, then you will see no savings from a lower rate.
Suppose it costs two points ($8,000) to reduce the interest rate on a $400,000 fixed-rate loan with a 30-year term from 4.5% to 4.0%. Your monthly mortgage payment for principal and interest would drop by $117 with the lower rate ($1,910 instead of $2,027).
- After five years at 4.0%, you’ll have paid $76,370 in interest payments, plus $8,000 in mortgage points, for a total of $84,370. You’ll have reduced your principal balance by $38,210
- With the 4.5% loan, you’ll have paid $86,236 in interest. You’ll have reduced your principal balance by just $35,368
In this case, then, it will cost you $1,888 less over five years if you pay the discount points. But that’s not all. You’ll have reduced your balance by an extra $2,842. So your total savings in five years is $4,730. Moreover, buying points will have saved you $10,000 in interest payments.
You can figure out your potential savings and break-even point by using a mortgage calculator.
How to shop for loans with mortgage discount points
When you’re shopping for a mortgage loan, it’s important to get multiple rate quotes and compare them on equal footing. Your quotes should include the same amount of points so you know which lender is truly offering the cheapest rate-and-fee combination.
Here’s an example. Say one national lender offers a 30-year fixed-rate mortgage at 4.5% with no points. You can knock 0.25% off that and get 4.25% by paying half a discount point. But a 4.125% rate (just 0.125% lower) costs an additional point. Paying more doesn’t necessarily get you a better deal.
When shopping for a mortgage with discount points, the easiest way to compare offers is to decide how much you want to spend, then see who offers the lowest rate at that price. Alternatively, you can decide what mortgage interest rate you want, and see which lender charges the least for it.
Mortgage discount points FAQ
Paying for mortgage discount points on an adjustable-rate mortgage (ARM) only provides a discount during the ARM’s initial fixed-rate period. With a 0.25 percent discount rate, it generally takes around 4-6 years of homeownership to break even with these loan terms. Therefore, your opening fixed-rate period should be longer than 4-6 years to see real savings.
Discount points and origination points are different. Origination points refer to the origination fees a borrower pays to their mortgage lender for processing and underwriting a home loan. Discount points are upfront fees home buyers pay at closing to reduce their mortgage interest rate.
One point typically costs 1 percent of your loan amount, or $1,000 for every $100,000 borrowed. As an example, if your mortgage loan is $400,000, then one discount point would be $4,000. Additionally, many mortgage lenders will allow home buyers to purchase fractional points. On a $4000,000 home loan, a half point would cost $2,000.
What are today’s interest rates?
Mortgage rates have risen from their recent all-time lows. But paying discount points can help you save even in a high-rate environment. To see what you qualify for, get preapproved by a mortgage lender. Ask your loan officer to show you rate quotes both with and without mortgage points so you know how much you could save on your rate — and what it would cost you.