Should you buy down a loan?

I have a client now, and have had clients in the past, who want to know whether or not they should pay points to buy down their loan.  First of all, let me say that I'm not a mortgage broker, and don't pretend to do lending.  I believe I should do what I do best, and let other professionals do what they do best.  Also, what I'm explaining here is a principle, so don't blog me back saying that you can beat this rate, and ask my client to call you.

What is a buydown? 

1. It is paying money upfront to the lender to get a better interest rate.  This money is in addition to the money needed to get your loan.  You might get preapproved for a 5.12% loan, but by paying an extra $2,500 you could get a 5% loan.  The amount paid is referred to as points.  One point is equal to one percentage point.  One point on a $300,000 loan would be $3000.  A half point would be $1500, and a quarter point would be $750.  Your lender will tell you how many points or fractions of a point you would have to pay to buydown your interest rate aka: buydown your loan.

Why buydown a rate? 

1. Buying down a rate makes the amount you end up spending at the end of your loan (lets say 30 years) less.  You could save tens of thousands of dollars in interest by buying down a loan. 
2. Buying down your loan may mean the difference between qualifying for a loan, and not qualifying.  The numbers used to decide if you qualify on a loan is based on the amount of monthly payment, not necessarily the the amount borrowed.  If buying your loan down lowers your payment by a few hundred dollars that may make the difference in your "qualifying figures".  It's is possible you could qualify for a mortgage with a $1470. mortgage, but not qualify if the amount was $1820.  Buying down the loan might be what makes the difference.

Why would a bank want me to buydown my interest rate:

1. Banks want you to borrow money.  If you don't qualify at a certain rate, the bank offers a better deal if you are willing to pay "upfront". You get your loan, and the bank gets your business.  Without buydowns, a lot of banks would not be able make loans to some people who were unable to qualify.
2. THE BANK MAKES MONEY!  I know it sounds crazy, but the bank stands to make more money on you by letting you buy down your interest rate.  This sounds a bit contrary to what I said earlier when I said you could save tens of thousands of dollars over the life of your loan but think about this.  The average family sells every 8 years.  They refinance even more frequently.  If you refinance or sell shortly after getting your loan, you will never see the benefits of the savings, and the bank wins by keeping the money you used to buydown your loan. 

Is it worth it?

1. Here's how to figure out if buying down your loan makes sense. 

You qualify for a 30 year fix rate loan of $100,000 at 5.12%, that would equal a monthly payment of $544.18   You can pay 1/4 point to buy down to 5% for the same loan.  The 1/4 point (or .25%) will cost you $250.  Your new payment would be $536.82.  The difference in the two loans is $7.26. 

It cost you $250 to save $7.26 each month.  How many months would it take before you break even?  Divide $7.26 into $250 and you get just a bit ove 34 months.  So you will need to keep your loan for almost 3 years before you start seeing any savings.  How much would you save during the course of the loan if you kept it for 30 years... ???

So that's it.  Easy to figure out with basic math.  You just need to understand the concept.  It's hard for an agent to know if you should buy down your loan, unless you won't qualify without the buy down, then the question is easy.  The real question is: Do you need to, and will you keep your loan long enough to see the reward?  Oh, the money you would have saved?  $2,649.