You can pay for a lower interest rate on your mortgage upfront, but whether you should depends on the math
- One option for homebuyers taking out a mortgage is to pay for a lower interest rate upfront, or "buy it down."
- While the ability to do this, and the impact of the payment, will vary by lender, buying down your rate means paying for mortgage "points" (fees) at the start of the loan to lower your interest rate and thus decrease your monthly payments going forward.
- Should you pay for a lower interest rate? It depends. This strategy usually works best for someone who will be in the home for at least five years, because that's about how long it usually takes to break even on the upfront cost from the monthly interest savings.
- Make sure to run the numbers, and to shop around for mortgage offers from different lenders to find the best rate for you.
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If you're shopping for a mortgage and not 100% satisfied with your interest rate, one option is to buy it down. "Buying down" your mortgage interest rate is a simple concept: You pay more money upfront to have a lower interest rate, and therefore pay less every month.
You're paying for a lower interest rate by buying what's called "points," which are fees paid directly to the lender in order to eliminate some interest over the lifetime of the loan. Usually, one "point" costs 1% of your total mortgage, or $1,000 for every $100,000. You can also buy fractions of a point, like a half point or a quarter point, for a lesser impact on your monthly interest rate.
Exactly how much your upfront payments impact your interest rate going forward will vary by lender, so it's worth exploring your options to find the best rate for you.
The impact of a lower interest rate can be huge. Run your numbers through a mortgage calculator to see exactly how much it will change your lifetime payments. For instance, one point on a $300,000 loan costs $3,000. Let's say paying for that point decreases your interest rate for a 30-year fixed-rate mortgage (using a 20% down payment) with a hypothetical lender from 4.0% to 3.5%.
Buying that point will save you $49 a month ... or $14,326 in interest over 30 years (provided you don't refinance).
Should I pay for a lower interest rate on my mortgage?
Before paying for a lower interest rate, calculate when you will break even.
Heidi Gage, a loan officer with over 20 years of experience in the mortgage industry, says buying down a mortgage interest rate with points usually makes sense when a borrower will be in the house for more than five years. That's because it usually takes at least five years to "break even" on what the borrower paid to lower the rate and actually start making back the difference.
In our hypothetical example of a $300,000 loan, the borrower will break even right around the five-year mark. To determine that timeline, divide the upfront cost of the point ($3,000) by the monthly savings ($49) to get 61.2 months, or about five years until the savings match the upfront cost.
Aside from planning to be in the home at least five years and calculating when you'd break even, there are also few more things to consider if you're thinking of buying down your rate:
What is your ideal mortgage amount and monthly payment?
You only want to pay down your mortgage if it's going to benefit you and secure a better rate. To figure out whether it will, make sure you know:
- How much of a down payment you want to pay
- How long you want your mortgage term to be
- What interest rate you're aiming for
- What monthly payments you can afford
Once you have an idea of what your ideal is, you'll be better prepared to know if buying down is a good option when you shop for your best rate.
Do you have enough in emergency savings?
Buying down your payment is probably not a good choice if you don't have a solid emergency fund saved for unexpected expenses. Experts generally recommend an emergency fund have three to six months' living expenses stored somewhere accessible, like a high-yield savings account. If paying down your mortgage decimates your savings and leaves you without a safety net, you'll never be in the black.
Is there a way to reduce closing costs?
Oftentimes, says Gage, the seller can assist with closing costs and help the buyer offset the cost of the point. You may want to speak with your realtor and your attorney (if you're in a state that requires one) about where the seller might be able (and willing) to pitch in.
There is a lot to consider when shopping for a mortgage. Whether you want to buy down your rate or not, Gage says that communication between the borrower, the lender, the realtor, and the seller is hands-down the best way to make home-buying go smoothly.
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