How to Buy Down Your Mortgage Interest Rate

Getting a lower interest rate on your mortgage can save you thousands of dollars. One way to do this is through a rate buydown. This guide will show you how it works and help you decide if it’s right for you.

What is a Rate Buydown

A rate buydown is when you pay money upfront to get a lower interest rate on your mortgage. Think of it as prepaying some of your interest. You give the lender cash at closing, and they give you a reduced rate for a certain time or for the whole loan.

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The money you pay is called discount points. Each point usually costs 1% of your loan amount. So if you borrow $300,000, one point would cost $3,000.

How Does Rate Buydown Work

When you buy down your interest rate, you’re essentially paying the lender to charge you less interest. The lender uses your upfront payment to make up for the lower monthly payments you’ll make.

Here’s a simple example: Let’s say your rate would normally be 7%. You pay $3,000 in points to bring it down to 6.5%. Your monthly payment drops, but you paid that $3,000 at closing.

The process is straightforward. You tell your lender you want to buy points. They calculate the cost and show you how much your payment will drop. You pay the points at closing, and your new lower rate starts right away.

Types of Mortgage Rate Buydowns

There are two main types of buydowns:

• Permanent Buydowns: You pay points to lower your rate for the entire loan. This is the most common type. You might pay 1-3 points to drop your interest rate by 0.25% to 0.75%.
• Temporary Buydowns: Your interest rate starts lower but goes up over time. The most popular versions are:

2-1 Buydown: Your interest rate is 2% lower in year one, 1% lower in year two, then jumps to the full rate for the remaining years.

3-2-1 Buydown: Your rate is 3% lower in year one, 2% lower in year two, 1% lower in year three, then goes to the full rate.

1-0 Buydown: Your rate is 1% lower in the first year only, then goes to the full rate.

With temporary buydowns, the seller or builder often pays the cost instead of you. This makes the home more affordable in the early years.

Cost to Buy Down Interest Rate

The cost depends on your loan size and how much you want to lower your rate. Here are typical costs:

Each discount point usually costs 1% of your loan amount. So on a $400,000 loan, one point costs $4,000.

Each point typically lowers your interest rate by 0.25%. Some lenders offer 0.125% or 0.375% reductions per point.

You can usually buy 1-4 points, though some lenders allow more. The more points you buy, the lower your rate goes.

For temporary buydowns, costs vary widely. A 2-1 buydown might cost $5,000-$15,000 depending on your loan size and rates.

Remember to factor in other closing costs too. Points are just one expense when buying a home.

Pros and Cons of Buying Down Interest Rate

Pros:

• Lower monthly payments save you money each month
• You pay less interest over the life of your loan
• The interest you prepay may be tax deductible
• It can help you qualify for a larger loan amount
• Your interest rate is locked in and won’t go up

Cons:

• You need cash upfront at closing
• It takes years to break even on the cost
• You lose money if you sell or refinance early
• That cash could be invested elsewhere for potentially higher returns
• You’re betting rates won’t drop significantly

The biggest downside is opportunity cost. That money you spend on points could go toward your down payment, emergency fund, or investments.

Buydown Alternatives

If buying points doesn’t make sense, consider these options:

Shop for Better Rates: Different lenders offer different rates. Even a small difference can save you more than buying points.

Improve Your Credit Score: A higher score gets you better rates naturally. Pay down debt and check your credit report for errors.

Make a Larger Down Payment: Putting down 20% or more often gets you better rates and eliminates private mortgage insurance.

Choose a Different Loan Type: Government loans like FHA or VA loans sometimes offer lower rates.

Wait for Rates to Drop: If rates are trending down, waiting might save you money without paying points.

Consider an ARM: Adjustable rate mortgages start with lower rates, though they can go up later.

Using a debt payoff calculator can help you see how different strategies affect your finances.

How Many Points Can You Buy Down Interest Rate

Most lenders let you buy 1-4 points. Each point typically reduces your rate by 0.25%, though this varies by lender and market conditions.

Some lenders allow fractional points, like 1.5 or 2.25 points. Others only sell whole points.

There’s usually a maximum. Most lenders cap you at 4 points, though some allow more. Very few borrowers buy more than 3 points because the value diminishes.

The exact reduction per point depends on current market conditions. When rates are high, points might give bigger reductions. When rates are low, each point might not drop your rate as much.

Is It Worth It to Buy Down Interest Rate

This depends on your situation. Here’s how to figure it out:

Calculate the Break-Even Point: Divide the cost of points by your monthly savings. If points cost $6,000 and save you $100 per month, you break even in 60 months.

Consider How Long You’ll Stay: If you’ll move or refinance before breaking even, points probably aren’t worth it.

Look at Your Cash Situation: Only buy points if you have plenty of cash left over for emergencies and other needs.

Compare to Other Investments: Could you earn more by investing that money elsewhere?

Check Tax Benefits: The IRS lets you deduct points in the year you pay them for your primary residence.

Points make the most sense when you plan to stay in the home for many years and have extra cash available.

When to Buy Down Mortgage Rate

The best times to consider buying points:

When You Have Extra Cash: Don’t drain your emergency fund or skip your down payment to buy points.

When You’re Staying Put: Points work best when you’ll keep the loan for many years.

When Rates Are High: Points can provide more value when starting rates are elevated.

When You Need Lower Payments: If slightly lower payments help you qualify or manage your budget, points might help.

When Tax Benefits Apply: If you can deduct the points, they become more valuable.

Don’t buy points if you might refinance soon, move within a few years, or need that cash for other purposes.

FAQ

Can I negotiate the cost of points? Sometimes. Some lenders have flexibility, especially if you’re shopping around. It never hurts to ask.

Do points affect my APR? Yes. Points are included in your APR calculation because they’re part of your total borrowing cost.

Can the seller pay for my points? Yes. This is common in buyer’s markets or with new construction. The seller pays the points, and you get the lower interest rate.

What happens to my points if I pay off early? You don’t get them back. This is why early payoff makes points less valuable.

Are points the same as down payment? No. Points are separate from your down payment. You pay both at closing.

Can I add points to my loan amount? Usually no. Most lenders require you to pay points in cash at closing.

Buying down your interest rate can save money if you plan carefully. Take time to run the numbers and consider your long-term plans before deciding. The key is making sure the upfront cost makes sense for your situation.