One of the most important decisions you must make when buying a home is the mortgage. Unfortunately, most buyers forget to factor in interest rates while shopping for lenders and loan options. Many, for instance, are unaware that they can buy down interest rates and avoid monetary hassles in the long run.Get A Free Mortgage Quote
What Does Buying Down Interest Rates Mean?
When you buy down interest rates, you agree to pay an upfront fee for a reduced interest rate on your mortgage. By prepaying some of the interest you would have to pay eventually throughout the loan duration, you reduce the monthly payments you must make.
The Role of Mortgage Points
One of the main ways you can buy down interest rates is via discount mortgage points. These points are charges that you pay to a lender at closing for a lower loan interest rate, which is about 1% of the total loan amount. This means one point for a $200,000 mortgage would be $2,000.
This is not to be confused with mandatory origination points. The origination fee is the amount owed to the lender for creating, processing, and evaluating your loan. Like a discount point, these are about 1% of the total mortgage and are part of the closing costs. Even if your lender doesn't ask for these charges, you may have to compensate by paying a higher interest rate.
Factors Influencing Cost of Points
The cost of mortgage points is not set in stone – they can vary per certain factors.
A large loan comes with higher upfront charges while you are purchasing points. While you may save money down the line in the amount you need to pay to cover the interest rate, you will have to pay a large sum upfront, which may not be within your means. If you have budget constraints, consider this option carefully.
Homeowners should also remember that a larger loan may lead to a longer breakeven period, i.e., the duration required to recoup upfront costs of the points via the reduced monthly payments. If you plan on staying in the home you bought for a long time, this is a good option. But if you opt for a loan amount that exceeds standard limits, the cost of the points may prove burdensome financially.
Your credit score will also determine the cost of the points. As a rule of thumb, individuals with higher scores can avail lower interest rates. The lender may also be flexible with pricing structures in a competitive market, which can reduce the price of the points.
Also, remember that the cost of points can differ across lenders. Some may offer favorable terms, while others may not. Make an informed decision by comparing rates first.Get A Free Mortgage Quote
Pros and Cons of Buying Down Interest Rates
Before buying down interest rates, evaluate the pros and cons to make an informed decision:
● Get an immediate reduction in monthly mortgage payments for more cash in hand.
● Save money for other expenses such as medical bills, education, and emergencies. Buying down interest rates is a good idea if you plan on staying in the home for years.
● Enjoy tax deductions. However, make sure you consult with a tax professional beforehand.
● Buyers must pay substantial upfront costs, which can be problematic if they are on a tight budget. It is also unwise to get points if you plan on selling or refinancing soon. Even if you will remain in the house for a while, you may have to refinance if interest rates spike. This will impact your mortgage interest rate.
● Mortgage interest rates fluctuate with market changes, which in turn, is affected by economic changes. So the answer to ‘how much does it cost to buy down interest rate’ depends on the lender and loan options you choose.
The Impact of Points on Interest Rates
Each point you buy will usually reduce the interest rate you owe on the mortgage by 0.25%. This means a 4.5% interest rate will go down to 4.25%.
Here is an example that makes this simpler. Let's say you get a $300,000 loan with a 4.5% interest rate. The cost of a single point will be $3,000, bringing down the rate to 4.25%. At this point, consider the time it will take you to recoup the cost of purchasing the point.
To do that, divide the upfront charges by the savings you will get every month, which will look something like this:
$3,000 (point cost)/ $22.5 (monthly savings) = 133 months.
In other words, it will take you at least 11 years to recoup the point cost. This option is financially feasible if you plan on remaining in your home for over a decade.
Which Mortgage Loan Should You Consider?
When you are shopping for mortgage loan offers, take a look at the annual percentage rate first. This is the complete cost of the loan, which also includes the paid points and lender fee. It will make things more transparent so you can make an informed decision while comparing rates and point combos.
After getting a quote, determine if buying down interest rates for a lower interest rate is feasible. Evaluating the charges and benefits of each mortgage option this way can protect you from financial ruin down the line.
While the immediate benefits of purchasing discount mortgage points are attractive, the significant upfront costs can have a domino effect on your life and finances.
Get the Best Interest Rates and Mortgage Options from LendGo
Understanding the nuances of mortgage options and interest rates can help you secure a deal that makes financial sense. LendGo can be your trusted partner for suitable and beneficial mortgage rates. Ask us about buying down interest rates for a custom pricing structure. Contact us for a consultation today. We can help you find what you need at pricing you can afford