“Buying Down” Your Interest Rate – What That Means, and When It Makes Sense

What does it mean to “buy down” my interest rate?

Essentially, every rate has a price.  And, to be clear, origination fees are the same as points – both are up front charges that are expressed as a percent of the loan.  For instance, a 1% origination fee (or point) on a $460,000 mortgage would equal $4,600.  So, how does this correlate to your interest rate?  I’ll try to explain.

When a lender quotes you a 4.49% rate with zero points, what they’re really saying is that the cost of this rate is zero to you.  For instance, zero points could mean that there is actually an origination fee, but the associated discount for 4.49% is equal to it, thus washing it out.  A lower rate may in fact be available, but it will likely cost you more money in closing costs.  An available 4.30% may yield only -.421 in discount points.  So, in this case, you would still have the 1% origination fee, but only .421, or $1,473.50, would be discounted.  Rather than the entire $4,600 being washed away, this 4.30% rate is actually costing you $2,026.50.  Please reference the chart below* based on a loan amount of $460,000:

Rate

1% Origination

Discount

Cost to You

P&I Payment

4.30%

$3,500.00

-.421 or -$1,473.50

$2,026.50

$2,276.41

4.375%

$3,500.00

-.638 or $2,934.80

$1,665.20

$2,296.72

4.40%

$3,500.00

-.710 or $3,266.00

$1,334.00

$2,303.51

4.49%

$3,500.00

-1.00 or $4,600.00

$0

$2,328.03

4.60%

$3,500.00

-1.264 or $5,814.40

-$1,214.40

$2,358.17

4.625%

$3,500.00

-1.327 or $6,104.20

-$1,504.20

$2,365.05

4.70%

$3,500.00

-1.518 or $6,982.80

-$2,382.80

$2,385.74

 

Here you can clearly see the impact of a lower rate on your immediate out-of-pocket expenses (closing costs).  Note in the “cost to you” column, if the figure shows a negative sign prior to the dollar amount, then that is a credit to you and lessens monies you will be required to bring to the closing table.   The question you would need to consider is whether the expense up-front is worth it for the lower rate amortized over a 15 or 30 year fixed term.  In other words, is the short-term cost of “buying down” the interest rate worth it in the long run, and do you have sufficient funds available to “buy down” the rate while maintaining sufficient cash reserves (if applicable to your loan product)? If you only plan on keeping the home for a short period of time, you would need to look at an amortization table to determine where the “break even” point is.  If you plan to hold the home for a long time, it very well may be worth it to pay the money up-front and realize the benefit of a lower rate.

Be sure to ask your lender how your rate is being quoted to make sure it’s the best option for you!

*This chart is for simplified illustration purposes only. It is not necessarily representative of any particular lender’s complete fee structure nor does it fully represent any specific loan product. Numerous factors will determine the products, interest rates, and “buy down” options available to individual buyers; be sure to discuss your options with your Loan Officer!