What does “buying” down an interest rate on a mortgage consist of?

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Is it as simple as previously mentioned to me? ie: Approaching your loan person saying you want to “buy” down your interest rate for your mortgage. Then after it is arranged you pay say $ 500 to lower your interest rate by a half percent. Is this accurate or how does it really work?

  1. Reply
    May 18, 2011 at 11:16 am

    Yes, it is.

  2. Reply
    May 18, 2011 at 12:01 pm

    You are referring to paying “Discount Points.” Tell your mortgage broker you want a particular rate and he will tell you if a) it is available and b) how much it will cost you. You can expect to pay about 3/8% for each 1/8th you drop in rate. I recommend buying down your rate under the following circumstances:

    1. Someone else is paying your closing costs and there is money available.
    2. You plan on being in this home for a substantial period of time, not just a few years.
    3. You have extra cash in the bank and you have no better alternative to investing it elsewhere.

    Hope this helps. Best of luck.

  3. Reply
    May 18, 2011 at 12:28 pm

    Yes, a buy down is simply giving money in advance to the lender in return for a lower rate. With rates at near record lows, buying down would not seem to be a good investment at this time.

  4. Reply
    May 18, 2011 at 12:28 pm

    You can “buy down” your interest rate thru paying “discount points”. The cost vs. drop in rate differs depending on how long your rate is fixed for. I.E., the most expensive loan to “buy down” is a 30-year fixed, since you are lowering your rate for the entire term of the loan. You usually get a bigger decrease in your rate when you “buy down” an adjustable rate mortgage, since you are only insuring that your rate is fixed for, let’s say, 3, 5, or 7 years.

    Discount points are considered prepaid interest, so if you are paying them for your primary residence, you can write them off on your taxes. Consult you tax advisor for more details.

    Paying points to lower your rate does not always make sense, so look at it like an investment. Here’s how to make sense of it:

    Let’s say that you have a loan of $ 100,000 with a zero point rate. By paying two points (2% of the loan amount=$ 2000) you can knock one percent off of your rate. By doing so, you are lowering your monthly payment by $ 100. Divide your monthly savings ($ 100) into the cost ($ 2000) and you’ll come up with a monthly break-even rate. In this instance, you would break-even in 20 months or less. I say “or less” because the fact that it’s tax-deductible could shorten your break-even period for the better.

    If it’s going to cost you $ 2000 to save $ 50 a month, this increases your timeline of breaking even out to 40 months. This may not make sense depending on a) how long you plan on staying in the home, and b) if you refinance before then, you’ve lost out.

    Hope this is helpful!

  5. Reply
    Suzanne C
    May 18, 2011 at 12:41 pm

    you know what’s fun? Ask the seller to pay a point for you. Your mortgage broker should be able to show you a table of how this affects your total payment. It’s dramatic how much you’ll save!

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