Have you heard the term “buying down your interest rate”? If you’re shopping around for a mortgage this question may have come up in conversation with potential mortgage advisors and lenders. But what exactly does it mean?
When you apply for a home loan you are typically given the opportunity to buy down the rate. This requires paying mortgage discount points which is a form of prepaid interest. These mortgage points, also known as discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate. You are literally paying the lender for a lower interest rate. This is appropriate when you might have a lower credit score and you’d like a better interest rate but your credit can’t support that. You can lower your monthly mortgage payments by buying down your rates. One point usually costs 1% of your mortgage amount or $1000 for every $100,000 of loan you are obtaining.
What you have to determine is if it makes sense, if you’re able to do it, and if the numbers match up. Most homeowners or prospective homeowners want the lowest rate possible, obviously. Having a lower interest rate could mean saving hundreds of thousands of dollars in interest over the life of your loan. However, this may mean a bigger upfront cost.
Some borrowers may opt for a higher mortgage rate to avoid paying closing costs or may pay a one time fee in exchange for a lower interest rate in order to save money over the long term. Of course, this strategy will only work if you plan on staying with the mortgage for a certain amount of time, at least 5 to 10 years.
But, buying down your rate might be a great option, especially if your lender suggests a higher interest rate and you’ve shopped around. If you pay these discount points at closing, you can bring your interest rate down to a lower level and save money each month with a lower payment. However, you have to decide if the monthly savings support the upfront cost. If you can buy down your mortgage rate for $2000 and literally save that $2000 in just a couple of years of mortgage payments, it probably makes sense. It’s worth it to scrape together that extra money to buy down your rate.
For more information or for some specific numbers on how much home you can afford, what your monthly mortgage payment would look like a based on the price of a home you are considering, and how much you can save you by buying down the rate, feel free to give us a call. We can give you all the upfront numbers and let you decide if this makes sense for your next home loan.