What Does It Mean To Buy Down Your Interest Rate

Dated: 02/06/2014

Views: 2257

When you speak with a lender to get pre qualified for a home loan, they may ask you if you want to "buy down the interest rate." It took me a few exposures to really grasp this concept so I want to give an introduction. Once you know about it, you can make an informed decision that could save you a lot of money in the long run. 

There are a few moving parts here, so let me identify terminology. A "point" is one percent of the loan amount. So for a $150,000 loan, one point = $1,500.
Next is the loan interest rate. Usually you will be quoted a base interest rate, and then a discount schedule. So, say the base rate is 5.25%. The lender may give you a 0.25% decrease for an up front payment of one point. (one percent of the loan amount) and an additional 0.125% for paying two points up front.
So in this example, if you paid $3,000 up front (2 points) you would now have an interest rate of 4.875%. Is this good, or desirable, or why would you even do this? 
To decide if this is a good deal, you need to look at the payments you would make. In this example, the difference between 5.25% and 4.875% on a $150,000 loan is about $34.00 per month. But you spent $3,000 for that privilege. So first divide $3,000 by $34 to learn that it would take about 88 months, or 7.35 years to break even on this deal. After that time you are saving money for the rest of the loan term. A total of $9,248 if you take the full 30 years to pay off the loan. 
So is this a good idea? It really will depend on your situation and goals. First of all, do you have the money available? Second, do you plan on keeping this home past the break even point? Be aware that the points you pay are in many cases tax deductible for the year you pay them. (Consult your tax professional to discuss your unique situation). 
Now you can sound like a pro when discussing this detail of your loan with your lender. 

Gavin McCaleb

Gavin has lived in Boise for over 20 years. In 2003 he got his start in real estate as an investor and since then he has personally bought and sold over 100 houses. He got licensed in 2009 and is now....

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