Buying Down Your Interest Rate

Many borrowers and prospective homeowners out there are looking for the lowest possible interest rate, even if it means pulling money out of their own pocket at the time of financing.

Though most borrowers usually opt for a higher mortgage rate to avoid paying closing costs when buying a home or refinancing, some savvy homeowners will pay the one-time fees and take a lower interest rate to save money over the long term.

Of course, this strategy only really makes sense if you plan to stay with the mortgage for a long period of time, as associated savings aren’t usually realized for several years.

Buying Down the Rate

If you’re working with a bank or mortgage broker, you can easily buy down your interest rate by asking for a series of different rates and associated costs. This is known as “buying down the rate,” and is common practice in the mortgage industry.

You may have seen mortgage advertisements for “no point mortgages” or “zero point mortgages,” and may be quick to jump on them. And though these no cost loans could serve you well to leverage your money, for borrowers who have decent asset reserves and plan to pay off their loan, buying down the interest rate may be a better idea.

Should you buy down your rate?

Deciding whether or not to buy down your interest rate can be tricky, but if you get your hands on a rate sheet, you can make the decision quite easily. Most mortgage programs have a system where you’ll pay a certain amount in “fee” for a specified change in interest rate.

For example, if your interest rate at the par rate is 6.25%, but you’d like a rate of 6%, you’ll need to buy down that rate by paying mortgage discount points.

Mortgage discount points are a form of prepaid interest that can lower your mortgage rate if you so desire.

A rate sheet may 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 point lower your interest rate?

If you look at the buy-down ratio for each rate, it isn’t exactly a perfect science. Well, at least not to us non-bankers. Usually as the interest rate goes lower, the price to buy down goes higher, often disproportionately. This actually makes sense because it gets increasingly expensive to go well below typical market rates.

As you can see, someone 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 to 5.75%. That probably wouldn’t make much sense.

This is why it’s important to decide on a pricing threshold where it makes sense to buy it down instead of chasing a certain rate.

For some reason, homeowners seem to have a specific interest rate in mind that they must have. It’s foolish to go after a precise rate, especially when the cost associated may eclipse the actual savings you’d accrue over time with the slightly lower 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.

Note: 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.  It also gets to a point where it no longer makes sense to keep going lower because the cost becomes excessive.

Look at a comparison of interest-only mortgage payments on a $500,000 loan amount

– Interest rate of 6.25% with a price of 0.00 Monthly payment: $2604.17
– Interest rate of 5.875% with a price of 1.00 Monthly payment: $2447.92

Total monthly savings: $156.25
Total cost to buy down rate to 5.875%: $5,000.00

It would take roughly 32 months to realize the savings associated with the lower rate of 5.875%. It may be worth it if you plan on staying in your home over a long period of time, but if not, it might be wise to stick with a slightly higher interest rate at no cost.

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 pick up and go after a year or less.

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.

Read more: How to pay off the mortgage early.



38 Comments

  1. Colin Robertson November 29, 2017 at 9:30 am -

    Jeff,

    Most mortgages are calculated monthly so it probably won’t yield any monetary benefit to pay a half of it early. You can ask your servicer to be sure but I doubt it will save any money. And it’s always important to ensure they’ll accept split payments to begin with.

  2. Jeff November 28, 2017 at 9:20 pm -

    Is it a good idea to split payment in half and pay two payments a month. Will this pay of the house faster and will more go to principal?

  3. Colin Robertson April 19, 2017 at 9:43 am -

    Harvey,

    To determine that you would need to use a calculator to see how much you’ll save each month at the lower rate and if it’s more than $5,000, it could be worthwhile. Also factor in principal pay down over that time. Alternatively, you could look at ARMs if you know for sure you’re selling in 5-7 years, though plans often change…

  4. Harvey Gregoire April 19, 2017 at 4:50 am -

    I was asked to buy down my rate is 4.375 for $5000 we can buy down to 4.08. Is this worth it? We plan on moving in 5 to 7 years

  5. Colin Robertson March 29, 2017 at 1:36 pm -

    Jackie,

    That’s a fairly long breakeven period, but if it’s a forever home it could make sense. Have you looked at other rates, such as 4.25%? Is there a happy medium? It’s also possible to pay extra each month and save money on interest that way.

  6. Jackie March 29, 2017 at 11:34 am -

    Hi,

    We’re working on Refi now. Our rate will be 4.375, or we have an option of buying down to 4.125 with $9,000. (That can be observed in to the loan). We’ll save $50/mo in 30 years, but it will take 10 years to get even. We don’t have a set plan for moving to anywhere else. We may or we may not. Should we consider buying it down?

  7. Maria February 23, 2017 at 3:24 pm -

    I got my house Aug. 2009, with an interest rate of 4.65, I did a buy down to 0.125% and it cost me 34,000. And it was worth it. My payments were 759.00 then a year later went down to 525.00. If I didn’t buy it down, my payments would gave been alot higher, like 1200.00 a month.I went through the NACA Program. That is NACA.COM

  8. Colin Robertson February 5, 2017 at 11:11 am -

    Amy,

    Good stuff! It’s important to consider how long you’ll actually keep the mortgage, as opposed to jumping on the lowest rate, as you said.

  9. Amy February 1, 2017 at 10:05 pm -

    We are buying our first home so this was all new to me. I did some calculating between rates and their points fees, etc. We decided on 3.25% because it saved us the most. It’s funny, paying about 2k more to lower it to 3.15% ended up with us losing money were we to stay for 30 years. I guess that’s for the people who don’t do the math and just jump on lowest rate no matter what?

    Anyway, after deciding on 3.25% with $2550 in points and origination fees I realized that we only plan to stay about 5 years and then sell (hoping to make money, we got a deal and are remodeling ourselves) so I needed an amortization chart/calculator to see if we even wanted to lower the 3.75% “free” rate.

    And the answer was no, we do not. We can keep $2550 in our hot little hands to go into the remodel because at 5 years we would have just gotten our money back plus about $550. We plan to save on interest by just making a double payment so we can control our future savings that way and I’m good with that ;)

  10. Bill November 19, 2016 at 9:13 am -

    Have the broker use the commission they earn from the lender to reduce the rate. Buying down should have to cost you … it should cost them to earn your business.

  11. Colin Robertson June 24, 2016 at 4:23 pm -

    Christina,

    A 15-year loan can certainly save a ton of interest vs. a 30-year, and it’ll obviously be paid off in half the time. You also get a lower interest rate as you mentioned. Buying it down more is your call, but would be beneficial as long as you keep the mortgage past the breakeven point where paying for it upfront is recaptured via enough lower monthly payments. But if you also make extra payments that would lessen the value of the bought down rate because you wouldn’t be paying as much interest over the life of the loan, if that makes sense.

  12. Christina June 22, 2016 at 9:12 am -

    Colin – I just started my refi to get lower rate (we’re at 4.675% now) and shorten our loan (28 yrs left now). We are in a high tax bracket and that higher rate didnt seem to make a difference to our bracket, so I’d like a lower rate on our home.

    I have to choose one of below:

    30 year – 4.0
    20 year – 4.0
    15 year – 3.375
    10 year – 3.5

    15 years looks great, and we are considering buying down another 1/2- to 1 point if possible, and just pay cash at the time of closing for this. Is this wise, and does this really save $ in the long haul? I’d like to retire in 10 years so I plan on making extra principle payments in order to do so.

    Thanks

  13. Colin Robertson February 17, 2016 at 9:28 am -

    Sonny,

    Makes sense if your goal is to pay off the mortgage and save money on interest, yes. Just mind stretching yourself too thin in the process if cash on hand is an issue.

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