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Should You Buy Down Your Mortgage Interest Rate?

Buying down your interest rate involves paying an upfront fee to your lender to reduce the interest rate on your loan. The key advantages of a buydown are that it increases your purchase power and reduces your total cost over the life of the loan. However, you must consider your long-term goals and if the expense is worth the cost.

How Does Buying Down Your Rate Work?

When you apply for a mortgage, you'll be offered an interest rate that's influenced by factors like market conditions, your credit score and the mortgage type. If you want to lower your rate, you can buy it down by paying a one-time fee at closing in exchange for a rate cut.

Understanding Points: The Cost of Buying Down

When you buy down the interest rate on a mortgage, you're buying mortgage points, also referred to as discount points. Points are essentially prepaid interest that can be purchased at closing to lower your mortgage interest rate for the life of the loan. One point, or 1% of the loan amount, typically reduces the interest rate by about 0.25%.

How Much Will I Save If I Buy One Mortgage Point?

That represents a savings of roughly $83 per month, which is about $992 per year and $29,754 over the course of a 30-year mortgage. If you buy down a mortgage with these terms, you will recoup the upfront cost of purchasing a discount point in a little more than five years.

Lender Credits vs. Mortgage Points

Some mortgage lenders may offer lender credits, which represent cash paid by the lender to cover some of your out-of-pocket closing expenses. However, lender credits will increase your monthly payments while buydowns will reduce them. You'll typically be locked into a higher interest rate with a lender credit.

Does Buying Down Make Sense with Current Mortgage Rates?

Mortgage rates have made buying a home more challenging in recent years. The average interest rate for a 30-year conventional mortgage is currently 6.9%, while 10-year fixed-rate mortgages are offered at around 6.17%. For context, the average rate for a 30-year conventional loan in January 2021 was 2.65%. When combined with record-high home prices, some prospective homebuyers find that these interest rates have potentially priced them out of the market.

What Is a 3-2-1 Buydown Mortgage?

A 3-2-1 buydown mortgage is a home loan where the borrower receives a lower interest rate over the first three years. The interest rate is cut by 3% in the first year, 2% in the second year and 1% in the third year. After the buydown period ends, the borrower pays the full interest rate for the remainder of the loan. A lender, homebuilder, or seller typically covers the cost of a 3-2-1 buydown to make a home more affordable to potential buyers.

How Much Should I Buy Down My Interest Rate?

The decision to buy down your rate will depend on several factors, including your down payment and closing costs, the purchase price of the home, the interest rate you qualify for, and how long you plan to stay in the home.

Short-Term Benefits

A reduced rate lowers the cost of monthly mortgage payments, which can make it easier to qualify for a home loan. A buydown can also help you qualify for a larger mortgage, allowing you to buy a more expensive home.

Long-Term Benefits

"The long-term savings from a lower interest rate can be substantial. Even a small reduction, like 0.25%, can result in thousands of dollars in interest savings over the life of the loan. For example, on a $300,000 loan with a 30-year term, lowering the interest rate from 6% to 5.75% could save you over $15,000 in interest payments."

— Carl Holman, A&D Mortgage

"Lowering your interest rate means that more of your monthly payment will go toward the principal balance you owe. This will build your equity more quickly."

— Rose Krieger, Home Loan Specialist at Churchill Mortgage

Determining the Break-Even Point

"The break-even point is when the amount you save on your monthly mortgage payments equals the upfront cost of buying down the rate."

— Carl Holman, A&D Mortgage

For example, if it costs you $4,000 to buy down the rate and you save $50 a month on your mortgage, your break-even point would be 80 months into the mortgage, or just over six and a half years. If you stay in the home longer than the break-even point, the money saved will outweigh the upfront cost.

The Opportunity Cost of Buying Down

"The funds used to buy points could instead be invested elsewhere, like in retirement savings or paying down higher-interest debt. It's important to weigh the potential returns from those other uses against the long-term savings from buying down your mortgage rate."

— Carl Holman, A&D Mortgage

"Putting a larger down payment on the home may reduce the mortgage interest rate anyway and depending on the amount, it may eliminate the requirement for mortgage insurance, which would in turn, lower your overall monthly payment."

— Rose Krieger, Home Loan Specialist at Churchill Mortgage

When to Buy Down Points

A mortgage buydown is generally worth it if you plan to stay in the home for a long time since a lower interest rate means you'll recoup the upfront cost. If you plan to sell in a few years or refinance to obtain a lower interest rate, a mortgage buydown is much less likely to pay off. It's also important to ensure that you have sufficient cash reserves to handle emergencies as a homeowner before depleting savings in pursuit of a lower interest rate.

Is It Worth It to Buy Down Your Rate?

Buying down the interest rate on a mortgage can reduce monthly mortgage payments and allow you to qualify for a larger mortgage. However, you should weigh the expense against your long-term goals before spending the money to bring your rate down a quarter-point or more.

Originally published on Homes.com · November 14, 2024.