Should You Buy Down Your Mortgage Interest Rate

In mortgage terms, buying down your interest rate is also called paying "discount points." Lenders typically offer mortgage programs with different interest rates andat varying costs. Borrowers can choose loans with higher rates and lower costs,or they can pay discount points to get a lower rate. That's how loans with identicalAPRs can look very different -- paying points is offset by lower rates, higherrates are offset by lower upfront costs. Borrowers can use mortgage calculatorsto determine which option best fits their investment and lifestyle plans.

Mortgage Calculator: APR Helps Determine Best Interest Rate Options

While paying points will always lower your interest rate it might not alwaysget you the best deal. It depends on the "bang for your buck" the lender is willingto offer, that is, how much discount points paid by you will actually reduceyour rate, and how long it takes to break even and recoup the extra cost of gettingthat lower rate.
One way of doing this is by using an APR calculator. Enter the loan amount, thenumber of points charged (usually one point to originate the loan plus discountpoints to get a lower rate), and the other costs. For example, a 30 year $300,000loan with 1 discount point and $3,000 in other costs and a stated rate of 6%has an APR of 6.19%. The same loan with no points has an APR of 6.6%. So, thelower APR is the best deal, right? Not necessarily.

Your Plans Are Important When Considering a Rate Buydown

  The $300,000 loan at 6% has a payment of $1799, and at 6.5% the payment increases  $97 to $1,896. So paying $3,000 saves you $97 per month. Assume that by not  paying the point you could be earning 5% interest on that $3,000 instead. That  $150 a year translates to $12.50 a month, so your real monthly savings is closer  to $85 a month. If you divide $3,000 by $85 you can see it takes over 35 months  to break even, and only after that do you start saving money. If you can afford  to pay the point and know you will have the loan longer than three years then  paying the extra is probably a smart move.
If you don't know how long you will keep the loan, consider these facts. FreddieMac estimates the average mortgage is held 3 years while the U.S. Census Bureauestimates fall between 6.2 and 7.5 years. Other sources differentiate betweenfirst homes and subsequent purchases, with first timers keeping their homes justover 3 years and second timers just over 5 years.

Considerations for Qualifying:

  If you need to have a lower rate and payment to qualify for your loan, you  may have no choice but to pay points to buy down the rate and get the payment  to a manageable amount. If purchasing property, you may even be able to talk  a motivated seller into paying the points for you.
An additional consideration is the rest of your financial picture. Don't paythat extra $3,000 if it will seriously deplete your savings. Lenders like tosee that you have enough in the bank to pay your mortgage and other bills forseveral months in case your source of income is interrupted. These funds arecalled "reserves" and constitute a safety net that shouldn't be tossed away lightly.
In general, the longer it takes to recoup the cost of points, the less attractivethe buydown is. When funds are limited and plans are uncertain it is almost alwaysbetter to take the loan with the fewest upfront costs.

Posted By :
Sheryl Landrum is a Loan Officer in San Diego, California and a freelance writer specializing in mortgage issues.

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