Buying Down Your Interest Rate

 

Many borrowers and potential homeowners look for the lowest possible interest rate, even if it means pulling money out of their pocket at the time of financing.

 

Though most borrowers take a higher interest rate to avoid any closing costs, some savvy homeowners will take the lowest possible interest rate and pay the one-time fees to save money in the long run.

If you're working with a bank or broker, you can easily buy down your interest rate by expressing what rate you'd like to pay, and inquiring about the cost to acquire such a rate. This is called buying down the rate, and is quite common in the mortgage industry.

Many potential borrowers see mortgage advertisements for "no point mortgages" or "zero point mortgages" and are quick to jump on them. While these no cost loans may serve well to leverage your money, for most borrowers who have decent asset reserves, buying down the interest rate may be a better idea.

Deciding whether to buy down your interest rate or not is fairly easy, and if you get your hands on a rate sheet, you can make the decision quite easily usually. Most mortgage programs have a system where you'll pay about .25 in fee for .125% in rate change.

For example, if your interest rate at the par rate is 6.25%, but you'd like a rate of 6%, you'll need to buy down that rate.

A rate sheet would look something like this:

Rate - Price

6.375% - -0.375

6.25% - 0.00

6.125% - 0.25

6.00% - 0.50

5.875% - 1.00

5.75% - 1.75

Each rate has a corresponding price, which is simply displayed as a percentage of the loan amount. A loan at the par rate would be 6.25% in the above example, as it has an associated price of zero.

If you look at the buy-down ratio for each rate, it isn't exactly a perfect science. Usually as the interest rate goes lower, the price goes higher, often disproportionately. That's why it's important to decide on a pricing threshold where it makes sense to buy it down.

Many homeowners may have a certain interest rate in mind that they must have. It's foolish to go after a certain rate, especially when the cost associated may eclipse the actual savings you'd accrue over time with the lower rate.

That's why it is important to compare your mortgage payment at different rates and the associated costs for buying down those rates.

Look at a comparison of interest-only mortgage payments:

$500,000 loan amount

Rate of 6.25% with a price of 0.00 Monthly payment: $2604.17

Rate of 5.875% with a price of 1.00 Monthly payment: $2447.92

Total savings monthly: $156.25

Total cost to buy down rate to 5.875%: $5000.00

It would take roughly 32 months to realize the savings associated with a rate of 5.875%. It may be worth it if you plan on staying in your home over a long period of time, but if not, it might be wise to stick with an interest rate with no cost.

Do the math to figure out which rate makes the best sense to buy down to based on your long term plan with the associated property. Buying down your interest rate can be a great decision, but also a foolish one if you pick up and go after a year or less. And don't fixate yourself on an exact interest rate. It simply isn't worth it sometimes, especially when the price doubles to drop the interest rate a mere eighth or quarter.

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