Should You Pay Points to Buy Your Interest Rate Down?

Since mortgage rates have returned to a more historically “normal” level, many are surprised that mortgage rates a bit higher than they may have been over the past few years. Mortgage rates have been pushed higher largely due to inflation. It’s expected by many industry experts that mortgage rates should improve to the mid-5% range somewhere between this summer to sometime next year. I do not expect to see mortgage rates for the 30 year fixed 4% anytime soon.

One option to reduce mortgage interest rates is to pay additional points, sometimes referred to as “discount points”. Points are an additional cost to your mortgage and can sometimes also be paid for by the seller if it’s negotiated in your purchase and sales agreement. It used to be that a point (1% of your loan amount) would reduce your interest rate by 0.25% in rate. How rates are priced varies throughout the day and sometimes you can lower your rate for less than a full point and sometimes it may cost more – it all depends on current market conditions. Mortgage rates are based on mortgage-backed securities (bonds) and move similar to stocks.

For example, if you have a loan amount of $400,000; one point would equal $4,000 (1% of the loan amount). If that point reduced the interest rate by 0.25; that would be a savings of roughly $65 per month (depending on the actual interest rate). If you were to take the cost of the discount point and divide it by the monthly savings, it will take roughly 61 months or 5 years to break even on that cost (4000/65 = 61.5) based on this scenario.

Here are some things to consider if you’re thinking about paying extra points to buy your interest rate down.

How long do you plan on keeping the mortgage? If you’re planning on selling in a couple of years or refinancing before you’ll be at the “break even” point, it may not be worth the extra cost. If you’re not planning on refinancing in the near future and you are going to keep your mortgage for a longer period of time (beyond the break even point); then buying down your interest rate with “points” may pencil out for you.

Do you need the lower monthly payment to qualify? If you’re barely qualifying for the mortgage payment, you might need to have a lower monthly mortgage payment to qualify. You may want to check with your loan officer to see if paying off debt is an option as well.

Is the seller contributing towards your closing costs? If the seller has agreed to contribute towards your allowable closing costs, you may want to look at doing either a seller-paid permanent or temporary buy-down of your interest rate.

Do you just really want that lower payment? A lower monthly payment and interest rate can feel more comfortable. I would encourage someone to look at paying off debt (possibly after closing – please check with your mortgage professional) before opting to paying additional points towards reducing an interest rate.

With how mortgage rates are priced, it doesn’t always cost a full point to reduce a rate by a quarter. Sometimes you can pay a small amount more to lower the rate by 0.125. It all depends on where pricing is at the moment you’re looking at interest rates and you are ready to commit to a rate lock.

Points are also typically a cost that is not reimbursed should you refinance or pay off the mortgage early. I say “typically” because with a seller-paid temporary buydown, if the mortgage is paid off before the amount of the subsidized buydown is used up, the leftover funds may be applied to the buyers principal balance/mortgage payoff.

Bottom line, it’s important to know your options and to make an informed decision.

Part of what I do for my clients is help them make strategic choices with their mortgage. If you’re looking at buying or refinancing a home, I am happy to help you!