Mortgage Buy Down

Paying out-of-pocket can reduce your interest rate

If you’re thinking about buying a home, you’ll probably need a loan to make up the difference between the sale price and how much you saved to use as a down payment. This type of loan is called a mortgage, and it works just like any other loan. With every monthly payment, you chip away at the principal of what you borrowed and pay a portion of the interest that accumulates on the balance.

Depending on the size of your mortgage and the rate you receive, the interest could wind up costing you a fortune in the long run. That’s why many hopeful homeowners look for the lowest possible rate, even if it means paying a significant fee out of pocket at the time of financing. This practice is known as “buying down the rate.”

What does it mean to buy down your interest rate?

When a homebuyer buys down her interest rate, she is literally paying an additional fee – in the form of mortgage discount points – in exchange for a lower interest rate on her mortgage. This might seem like a crazy idea, but it’s actually pretty common in the mortgage industry, as it can help the homebuyer save money over the long term.

Here’s how it works. A mortgage discount point is equal to 1% of your mortgage. Most mortgage companies offer a 0.25% rate reduction when a homebuyer purchases one point. It may seem like you’re getting the short end of the stick, but when you’re dealing with a loan amount in the six-figure range, even the slightest difference in your interest rate can have a huge impact on your bottom line.

For example, say you have a mortgage for $200K with an interest rate of 4.00%. Paying an extra $2K up front will reduce your rate to 3.75%. If you stay in your home for the entire life of the loan, you can save over $10K in interest. Have enough cash to buy two points? Lucky you. A $200K loan with an interest rate of 3.50% can slash the amount of interest you pay by $20K.

Is buying down your interest rate a good idea?

Buying a lower interest rate isn’t for everyone. Between coming up with a down payment, closing costs, and all of the other expenses that come along with buying a new house, many homebuyers are strapped for cash at the time of financing. But, if you can afford it, buying down your interest rate definitely has its perks – especially if you plan to stick around long enough to realize the long-term savings.

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