When you’re buying a home, an important choice to think about is whether to lower your mortgage interest rate. The interest rate is a big factor in how much you pay every month for your mortgage. It might seem like a good idea to reduce these rates and lower your monthly payments. However, it’s not a simple decision. There are many things to consider, like your money situation, your personal life, and what’s happening in the housing market. In this article, we talk to experts about common questions people have when they’re thinking about lowering their mortgage and other important things you should know. This will help you decide if it’s the right choice for you.
What is a buy down?
A buy down, sometimes called “paying points,” is a money strategy used in mortgages and loans to lower the interest rate. Here’s how it works: you pay a fee when you start the loan, and that helps to bring down the interest rate for the whole time you’re paying back the loan. This upfront fee, called points, is usually a percentage of the loan amount. Whether or not you should do a buy down depends on your own money situation and how long you plan to have the loan.
How does buying down an interest rate work?
“Buying down an interest rate, often referred to as “paying points,” is a financial strategy used in mortgage and loan transactions to reduce the interest rate you pay on your loan,” explains Al Gray, Loan Advisor from NEXA Mortgage. “This is when you pay extra money at the beginning of a loan to make your borrowing cheaper over time. The decision to buy down your interest rate by purchasing points at the beginning depends on your individual financial situation and how long you plan to keep the loan.”
For example, if you’re taking out a $200,000 mortgage and the lender offers a 30-year fixed rate at 6.5%, you might have the option to buy points at a cost of 1% of the loan amount each. You could buy two points for $4,000 (1% x 2 x $200,000), which would reduce your interest rate, often by 0.25% per point. In this example, with two points, your interest rate would be reduced from 6.5% to 6.0%.
Figure out how much money you’ll save each month with the lower interest rate and compare it to the upfront cost of the points. The break-even point is the time it takes for your monthly savings to recoup the upfront cost. If you plan to stay in the home long enough to break even and then benefit from the lower rate, buying points can be a smart financial decision. If not, it might be better to go with the regular interest rate.
In what circumstances is it a good idea to buy down your mortgage interest rate?
- Thinking about owning your home for a long time: If you plan to stay in your home for a long time, it makes more sense to buy down your interest rate. Even though there are upfront costs, the money you save on monthly payments over a long period can make it worth it.
- When the housing market is not great: Consider buying down your interest rate when interest rates are high compared to how they usually are. It’s a smarter move to lower your rate when rates are high.
- Having enough money when you close the deal: If you have enough money when you buy the house, you might want to think about buying points. You can cover the upfront cost, and the money you save over time can be more than what you initially paid.
- Having a really good credit score: If your credit score is high, you might be able to get better terms when you buy down your interest rate. Lenders may offer better rates to people with excellent credit.
- Being financially stable: Choose to buy down your interest rate when your money situation is stable. Make sure you can handle the upfront costs without causing problems for your overall finances.
- Wanting lower monthly payments: If your main goal is to have lower monthly mortgage payments, buying down the interest rate can help with that. This is especially true when you balance it with the break-even point.
- Expecting more money soon: Think about a temporary buy down if you think you’ll be making more money in the near future. This is like a short-term strategy.
- Not planning to refinance soon: If you don’t plan on refinancing your loan anytime soon, buying down the interest rate is a smart choice. This way, you get the benefits of the lower rate for the entire time you’re paying off the loan.
Is it good to buy down an interest rate?
“Buying down an interest rate can be a smart money choice in certain situations,” suggests Ahmed Hachim, Vice President and Consumer Mortgage Specialist at Burke & Herbert Bank. “This means paying extra money at the beginning to get a lower mortgage interest rate. It can make your monthly payments smaller and save you money in the long run. But it’s important to think about the upfront costs compared to the benefits in the future. If you plan to live in your home for a long time, buying down the rate might be helpful. This gives you more time to cover the upfront expenses with lower monthly payments.
On the flip side, if you think you’ll sell or refinance soon, the initial cost might not be worth it. It’s crucial to figure out the break-even point, where your savings become more than what you paid upfront. Talking to a mortgage expert or financial advisor can give you personalized advice based on your specific money goals.”
Temporary buy down vs. permanent buy down: What’s the difference?
Temporary buy down: This is a short-term money strategy for a mortgage. It means the initial interest rate on the loan is lower for a set time, usually the first few years. People who choose this might pay more money upfront or agree to a higher interest rate later on to have lower monthly payments at the beginning. It’s a good option if you expect to make more money soon or plan to refinance in a few years. Temporary buy downs make it easier to afford a home in the early years of the loan.
Permanent buy down: On the other hand, a permanent buy down means the interest rate stays lower for the whole time you’re paying back the loan. You pay more upfront to get a lower interest rate for the entire mortgage. Unlike a temporary buy down, the benefits of a permanent buy down stick around for the whole loan, giving you steady savings on monthly payments. People who go for a permanent buy down usually want the reliability of lower payments for the entire loan.
Understanding the difference between temporary and permanent buy downs is important. It helps you match your money plan with your own financial goals and how you want to own a home.
Let’s take a closer look at what mortgage points are.
Mortgage points are special payments you make when you’re closing a mortgage deal. In exchange, you get a lower interest rate and smaller monthly payments on the loan. This is also known as “buying down the rate,” a money strategy where homebuyers pay extra fees upfront to make their long-term financial situation better. But there are two main kinds of mortgage points:
- Discount points: These are payments made to lower the interest rate on the mortgage. The more discount points you buy, the more the interest rate goes down. How much it goes down depends on the lender’s rules, the type of loan, and what’s happening in the housing market. Usually, buyers can expect to drop their interest rate by one-eighth to one-quarter of a percent for each point they buy.It’s important to note that the first $750,000 of the mortgage loan’s points are tax-deductible. When you’re deciding on discount points, think about how long you’ll stay in the house and how much money you have when you close. The longer you plan to live in the house, the more worth it becomes to buy discount points.
- Origination points: These points cover the costs the lender faces when processing the loan. Unlike discount points, origination points don’t directly make the interest rate lower. Instead, they are part of the overall closing costs. The ability to talk about the terms of origination points can change, and some lenders might include them based on your credit or overall borrowing situation. Unlike discount points, origination points aren’t tax-deductible. However, some lenders now offer flat-fee or no-fee mortgages, especially for people with good credit, so you might not need origination points in some cases.