Some existing and prospective homeowners out there are fixated on obtaining the lowest possible rate even if it means paying out of their own pocket. Most borrowers opt for a higher mortgage rate to help pay for closing costs when buying a home, while some savvy homeowners will pay a one-time fee (discount points) in exchange for a lower interest rate to save money over the long term. This strategy only makes sense if you plan to stay with the mortgage for a decent amount of time, as savings are not seen for several years.
When you apply for a home loan you will be given the opportunity to buy down your rate this requires paying mortgage discount points which is a form of prepaid interest. The lender is betting that you will refinance or sell before you realize the savings from buying down the rate. Lenders know that home owners sell or refinance on average every 5 years.
When working with your Mortgage Loan Officer, you can easily buy down your interest rate by asking for several different rates and their costs. This is known as “buying down the rate,” and is common in the mortgage industry.
If you pay discount points at closing, aside from any commissions and any other lender fees, you can bring your interest rate down to a lower level, saving money each month via a lower mortgage payment.
For example, if your Mortgage Loan Officer says you qualify for a 30-year fixed mortgage at 4.25% with no points, but you want a rate of say 3.875%, you can ask them, “What is the cost to get 3.875% as my rate?”. They may come back and tell you that it will cost one point to buy down the rate, at which point you’ll need to decide if the monthly savings support the upfront cost.
You need to do the math. If that mortgage point sets you back $2,000 at closing and you are saving $20 a month on your payment, you need to divide 2000 by 20. This will tell you how many months you need to make the lower payment to break even. In this example that it would be it 100 payments or 8.3 years.
Should you buy your rate down?
This is a very important question and you should base it on how long it will take to recoup the cost, not bragging rights that you have a lower rate or some emotional number you have decide you must have as a rate.
It is important to remember that lenders have years of data and know exactly how much money they are making on every dollar borrowed at each different rate. There is not one mortgage rate, but a rate sheet that shows the PAR RATE (no points) for that day and then a series of rates above and below par. A rate sheet might look something like this:
Interest Rate – Price
6.375% – (0.375)
6.25% – 0.00
6.125% – 0.25
6.00% – 0.50
5.875% – 1.00
5.75% – 1.75
Each rate has a corresponding price, which is simply displayed as a percentage of the loan amount. In the example above, the par rate would be 6.25%, as it has an associated price of zero.
How much does 1 Discount Point lower the rate?
There isn’t one specific ratio and it can vary by lender. It takes some shopping and math to find the sweet spot where the buy down makes sense.
Typically, as the interest rate goes lower, the price to buy down goes higher, often disproportionately. It gets increasingly expensive to go well below typical market rates and investors are going to demand a higher premium. Remember, the bank is always going to get the interest they want either in rate or in discount points. You only win as the borrower if you keep the loan longer than the recoup period. You could pay one point for a rate of 5.875%, but be asked to pay nearly double that to get the rate down another eighth of a percent to 5.75%. This doesn’t make sense to do. Also, avoid the 6.00% vs. 5.99% trick. Lenders use this often and not just in-home buying. It is an emotional buying trick and they are steering you to a rate that they make more money or fees on.
For some reason, homeowners seem to have a specific interest rate in mind that they must have. It’s foolish to go after an exact rate, especially when the cost associated may eclipse the actual savings you would accrue over time with the slightly lower rate. Budget and compare payments and closing costs. Lenders use rate today as a selling tool and hope that their lower rate offer will get you to not pay attention to the fees associated with that rate.
Even if you have your heart set on X rate, you may want to see what the lender is offering, then compare your mortgage payment at different rates and consider the associated costs for buying down to those rates. There may be a limit to how many mortgage points you can buy based on the new QM rules, along with how low the lender is willing to go. There is always a point where it no longer makes sense to keep going lower, the cost becomes excessive.
Don’t talk about paying points when you are first shopping for your home loan to ensure you’re getting the best offers. Make sure you are comparing apples to apples when shopping. Once you have picked a mortgage company you are comfortable with, then ask your Mortgage Loan Officer about buydowns.
It is in your best interest (literally) to keep your intention of buying the rate down to yourself, at least initially. If you tell the Mortgage Loan Officer that you’re willing to pay points, they may think it’s okay to offer a higher rate than they would of initially without that information. Eventually leading you towards a higher buy down than you would have gotten if they did not have that information in advance.
Do the math to figure out which rate makes the best sense to buy down based on your long-term plan with the associated property.
Buying down your interest rate can be a great decision, but also a foolish one if you pack up and move in the first few years or less or quickly refinance when rates drop.
And remember, don’t focus on an exact interest rate. It simply isn’t worth it sometimes, especially when the price doubles to drop the interest rate a mere eighth or quarter percentage point.