Did you know there’s a way to buy down your interest rate on your home mortgage? It doesn’t matter if you’re purchasing or mortgage refinancing, if you’ve got the cash buying down your interest rate is an option. The question becomes should you consider buying down your interest rate? After all, the more cash you’re paying out-of-pocket, the less benefit you’re getting from today’s low rates. Here’s what you need to know to make an informed decision for your next home loan without leaving cash on the table.
Buying Down Your Interest Rate With Points
Many homeowners have a singular thought when it comes to their home loan…get the lowest interest rates possible, often at the expense of fees. This refinancing strategy isn’t necessarily a mistake, if you plan on keeping your home and never refinancing.
You can buy down your interest rate when refinancing by asking your loan originator for different interest rates and points. Most lenders quote various rates including points by default; however, working with a good broker can often help you get a better deal.
What are points? Discount points are simply a fee you pay the lender for buying down your interest rate. One point is one percent of your home loan amount and reduces your rates by .25% in the form of prepaid interest.
Most lenders quote refinance rates that include points automatically; however, zero or no point mortgages are a popular option. You might be asking yourself since mortgage rates are near sixty-year lows does it make sense to pay discount points?
Should You Buy Down Your Mortgage Rates?
Choosing the best option for your next home loan can be tricky, especially when it comes to taking cash out of your pocket. If your broker will give you a copy of the lenders rate sheet it might help you make an informed decision based on that lender’s par rate.
Par Mortgage Rate Definition: Interest rates that do not include markup for the broker’s commission or discount points
Suppose you’re considering NFCU Mortgage Rates and the par rate is 4.75 percent but you’re after 4.5 percent. Paying one discount point at closing has the effect of buying down your interest rate to 4.5 percent.
Your Mortgage Broker’s refinance rate sheet looks something like this:
Mortgage Rate vs. Price (Discount Points)
- 5.375% – (0.375) Yield Spread Premium
- 5.25% – 0.00 Zero Point Option
- 5.125% – 0.25 discount points
- 5.00% – 0.50 discount points
- 4.875% – 1.00 discount points
- 5.75% – 1.75 discount points
Each mortgage rate quoted has a price paid at closing in the form of points. In this example the par rate is 5.25 percent and the highest rate at 5.375 includes Yield Spread Premium. Higher discount point options have lower interest rates but higher costs. The more you want to buy down your interest rate the more it’s going to cost you at closing.
One common mortgage mistake when refinancing is to go after the lowest possible interest rate at the expense of fees. While it’s true that paying discount points will get you lower refinance rates and a lower payment it makes recouping your out-of-pocket expenses more difficult.
Here’s an example to illustrate how discount points lowers your monthly payment on a $250,000 mortgage:
- Refinancing with a par mortgage rate of 4.5% gets you a payment of $1,113 per month.
- Refinancing with one discount point gets you 4.25% and a payment of $983 per month.
- Cost for buying down your mortgage rate: $2500
- Monthly payment savings: $130
Is it worth paying discount points for buying down your interest rate? The more you pay out-of-pocket at closing the less benefit you’re getting from today’s low refinance rates AND the longer it’s going to take to break even recouping your expenses. In this case it’s going to take you 20 months just to break even on the points, even longer for your closing costs.
If you’re not able to break even recouping your closing costs before you sell or another mortgage refinance you’re wasting your money buying down your interest rate. You should note that approximating your break-even point by dividing your cost by the monthly savings is only valid if you keep the same term length or shorten your mortgage’s term. If you lengthen your term length by going from a 15-year to a 30 or even a 40-year mortgage it’s going to be impossible to break even given the finance costs of those extra years.
Does buying down your interest rate make sense in today’s market? You can do the math for yourself; however, given that the average homeowner refinances every four or five years discount points are a waste of money for most homeowners.
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