So What Does it Mean When You “Buy Down the Rate?”
One way to lower your mortgage interest rate when purchasing a home is to do what is called “buy down” the rate. It means paying a fee when you first purchase the home to reduce the interest rate. The idea is, that you pay extra money at the beginning of the loan to lower the monthly payment over the life of the loan.
The Formula to Buy Down the Rate
One percent (also called a point or a discount point) usually costs 1% of the loan amount and reduces the interest rate by about 0.25%. So for example, if you are getting a $300,000 mortgage, 1% of that would cost $3000 and reduce your interest rate by .25%. If your interest rate is 7%, after the buy down it’s now 6.75%. Your monthly payment goes from $1996 to $1946, saving you $50 a month.
The amount of interest your mortgage company is charging dictates how much home you can afford. A lower interest rate means a lower payment. If you can afford to pay the up-front points, it seems like a good idea. However, there’s another factor to take a look at, the break-even point.
Let’s say you decide to buy down the mortgage rate on that 7%, $300,000 mortgage by one point. You spend $3000 to get the lower rate of 6.75%. If you divide the $300,000 by your monthly savings of $50 you get 60. It will take you 60 months (5 years) to break even on your investment of $3000 to get the lower interest rate. The big question is, “How long do I think I’ll be staying in this home?” If you’re staying less than 5 years in this scenario, you might want to use that money for a bigger downpayment or improvements to the home.
Sellers Might Consider Buying Down
There’s one additional thing about the rate buy-down as it relates to the current market – a buyer’s market. Sellers are seeing long wait times before their homes go under contract. They are often eager not only to come down in price but offer incentives like buying down the interest rate for a buyer. It’s all negotiable!
